Question

The Marigold 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, Marigold has decided to locate a new factory in the Panama City area. Marigold 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 $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:

The solution the given problem is done below.

Explanation:

Building A: Purchase for a cash price of $600,000, useful life 25 years.

—PV = $600,000.

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

Rent X (PV of annuity due of 25 periods at 12%)

PV  =$69,000 X 8.78432

PV=$606,118.08

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.

PV of Building C—

Rent X (PV of ordinary annuity of 25 periods at 12%)

=$7,000 X 7.84314

PV=$54,901.98

Cashpurchasepriceof…………….$650,000.00

PV of rental income,……………..(54,901.98)

Net present value…………………..$595,098.02

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

Lease Building C since the present value of its net cost is the smallest.