Question

The Black Knights 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, Black Knights has decided to locate a new factory in the Panama City area. Black Knights 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 buildings.
Building A: Purchase for a cash price of $600,000, useful life 25 years.

Building B: Lease for 25 years with annual lease payments of $69,000 being made at the beginning of the year. Building

C: Purchase for $650,000 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $7,000. Rental payments will be received at the end of each year. The Black Knights Inc. has no aversion to being a landlord

Instructions

In which building would you recommend that The Black Knights Inc. locate, assuming a 12% cost of funds?

Answer 1

Answer:

Option C has a lower present worth, thus his cost is lower than other options after, considering time value of money 595,098.03

Explanation:

Option A present worth 600,000

Option B present worth of annuity-due

$C \times \frac{1-(1+r)^{-time} }{rate}(1+r) = PV$

C $  69,000

time     25 years

rate           0.12

$69000 \times \frac{1-(1+0.12)^{-25} }{0.12}(1+0.12) = PV$

PV $606,117.7906

Option C

650,000 cash payment less present value of the rental space:

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$

C $ 7,000

time 25 years

rate 0.12

$7000 \times \frac{1-(1+0.12)^{-25} }{0.12} = PV$

PV $54,901.9738

650,000 - 54,901.97 = 595,098.03