The owners of a cocktail bar have the following annual income statement information:

Annual sales revenue $210,000

Cost of sales (30% of sales revenue) 63,000

Payroll expense 50,000

Other operating expenses 20,000

Direct expenses (charges including depreciation) 40,000

The owners are considering new furnishings for the bar at an estimated cost

of $20,000 using their own funds. They anticipate the new furnishings will

bring in additional customers, and their sales revenue will increase by

10% above their current level. The new furnishings are estimated to have

a five-year life with no residual value. The new furnishings will be

depreciated using straight-line depreciation.

To provide service to the additional customers, more staff would be hired at an

additional cost of $125 per week. Other operating costs will increase by $1,400

per year. There will be no increase to direct (fixed) charges other than

depreciation expense. The income tax rate will remain at 25%. The owners

will go ahead with the project only if the return on their $20,000 investment

is 15% per year or more in the first year.

a. Should they make the $20,000 investment in new furnishings?

(HINT: do a projected incremental income statement)

b. If they had the alternative of using only $10,000 of their own funds

and borrowing the other $10,000 at 10% interest, would the decision change?