Question

Timberlake Company owns equipment with a cost of $165,000 and accumulated depreciation of $60,000 that can be sold for $82,000 less a 6% sales commission. Alternatively, Timberlake Company can lease the equipment to another company for five years for a total of $84,600, at the end of which there is no residual value. In addition, the repair, insurance, and property tax expense that would be incurred by Timberlake Company on the equipment would total $7,950 over the five years. Prepare a differential analysis on March 23 as to whether Timberlake Company should lease (Alternative 1) or sell (Alternative 2) the equipment. For those boxes in which you must enter subtracted or negative numbers use a minus sign.

Answer 1

Answer:

Income (loss) 77080 76650

Explanation:

Timberlake Company

Sell Lease

Revenue 82000 84600

Expense -4920 -7950

Income (loss) 77080 76650

Therefore Company should sell the equipment

6%×82,000 =4920

Answer 2

Answer:

Timberlake Company

Differential Analysis on March 23:

a) Lease (Alternative 1):

Revenue = $84,600

Expenses = -$7,950

Income = $76,650

b) Sell (Alternative 2):

Revenue = $82,000

6% Sales Commission = -$4,920

Income = $77,080

Explanation:

Alternative 2 looks more attractive than alternative 1.  It will bring in a net income of $77,080 as opposed to alternative 1's .$76,650.

Moreso, alternative 2's cash inflow is immediate while alternative 1's cash inflow will come over a 5-year period.  When discounted, the cash inflow will be far less than Alternative 2's cash inflow.

It is true that both alternatives will cause the company to lose on the book value of the equipment.  But the cost of the equipment is a sunk cost, which is not relevant in making a differential analysis type of decision.

In differential analysis, only relevant costs are considered.