Question

The Porter Beverage Factory owns a building for its operations. Porter uses only half of the building and is considering two options for the unused space. The Popcorn Store would like to purchase the half of the building that is not being used for $550,000. A 5% commission would have to be paid at the time of purchase. Salty Snacks would like to lease half of the building for the next five years at $100,000 each year. Porter would have to continue paying $15,000 of property taxes each year and $2,000 of yearly insurance on the property, according to the proposed lease agreement. Determine the differential income or loss from the lease alternative. $

Answer 1

Answer:

The Porter Beverage Factory

Two Options for unused Building: Income

Option a) Net Income:

Building purchase = $550,000

less 5% commission = $27,500

Net Income = $522,500

Option b) Net Income:

Lease Income = $500,000 ($100,000 x 5)

Less Property Taxes = $15,000

Less Insurance = $2,000

Net Income = $483,000

Differential Income or Loss from the Lease Alternative:

Net Lease Income = $483,000

less purchase income = $522,500

Differential Loss = $39,500

Explanation:

The outright sale would yield income after sales commission of $522,500 in the first year.

The lease agreement would yield income after expenses of $483,000.  The Present value would even be less, when calculated for the five years of lease payment.

Considering these two options, the outright sale looks more beneficial in dollar terms in the short-run.  However, it is important to note that the lease agreement is only for 5 years unlike the outright sale, which lasts forever.  Afterall, after the end of the lease term, the building space could still be sold.