Question

The Skysong Inc., a manufacturer of low-sugar, low-sodium, low-cholesterol TV dinners, would like to increase its market share in the Sunbelt. In order to do so, Skysong has decided to locate a new factory in the Panama City area. Skysong will either buy or lease a site depending upon which is more advantageous. The site location committee has narrowed down the available sites to the following three very similar buildings that will meet their needs. Building A: Purchase for a cash price of $620,000, useful life 27 years. Building B: Lease for 27 years with annual lease payments of $71,170 being made at the beginning of the year. Building C: Purchase for $657,500 cash. This building is larger than needed; however, the excess space can be sublet for 27 years at a net annual rental of $6,200. Rental payments will be received at the end of each year. The Skysong Inc. has no aversion to being a landlord. Click here to view factor tables In which building would you recommend that The Skysong Inc. locate, assuming a 11% cost of funds

Answer 1

Answer:

Building C

Explanation:

Building A: Purchase for a cash price of $620,000, useful life 27 years.

Building B: Lease for 27 years with annual lease payments of $71,170 being made at the beginning of the year.

Building C: Purchase for $657,500 cash. This building is larger than needed; however, the excess space can be sublet for 27 years at a net annual rental of $6,200. Rental payments will be received at the end of each year.

11% cost of funds

we must determine the present value of each option:

• Building A's present value = $620,000
• Building B's present value = $71,170 x 9.48806 (PV annuity due factor, 11%, 27 periods) = $375,265.23
• Building C's present value = $657,500 - [$6,200 x 8.5478 (PV ordinary annuity factor, 11%, 27 periods) = $657,500 - $52,996.36 = $604,503.64 (LOWEST PV)