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Leasing vs. Selling Equipment: A Differential Analysis for Decision-Making

In this analysis, we examine the financial implications of leasing versus selling equipment for Marcus Company. The equipment has a book value of $80,000 with potential lease revenues of $160,000 over five years against estimated expenses of $35,000. Alternatively, selling the equipment yields a sales price of $100,000 minus a 6% sales commission. We emphasize that the book value is a sunk cost and irrelevant for decision-making. Additionally, we discuss the considerations for discontinuing unprofitable products, using Bran Flakes from Battle Creek Cereal Co. as a case study.

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Leasing vs. Selling Equipment: A Differential Analysis for Decision-Making

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  1. Differential Analysis, Product Pricing, and Activity-Based Costing LO 1b – Leasing/Selling Equipment and Discontinuation of Segment Decisions

  2. LO 1 Lease or Sell On June 22, 2012, Marcus Company is considering leasing or disposing of the following equipment: Cost of equipment $200,000 Less accumulated depreciation 120,000 Book value $ 80,000 Lease Option: Total revenue for five-year lease 160,000 Total estimated repair, insurance, and property tax expenses during life of lease 35,000 Residual value at end of 5th year of lease 0 Sell Option: Sales price $100,000 Commission on sales 6% (continued)

  3. LO 1 Lease or Sell Lease the equipment (continued)

  4. LO 1 Lease or Sell • The $80,000 book value of the equipment is a sunk cost and is not considered in the differential analysis. • Sunk costs are costs that have been incurred in the past, cannot be recouped, and are not relevant to future decisions.

  5. LO 1 Discontinue a Segment or Product • Management may consider discontinuing a product or segment of a business that is generating losses. Based on the information in the condensed income statement in Exhibit 3 (next slide), management of Battle Creek Cereal Co. is considering discontinuing Bran Flakes.

  6. LO 1 Discontinue a Segment or Product • Discontinuing the product or segment usually eliminates all of the product or segment’s variable costs (direct materials, direct labor, sales commissions, and so on). However, the fixed costs (depreciation, insurance, property taxes, and so on) may not be decreased.

  7. LO 1 Discontinue a Segment or Product

  8. LO 1 Discontinue a Segment or Product Don’t discontinue Bran Flakes!

  9. LO 1 Discontinue a Segment or Product

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