Question

Flint Inc. owns and operates a number of hardware stores in the New England region. Recently, the company has decided to locate another store in a rapidly growing area of Maryland. The company is trying to decide whether to purchase or lease the building and related facilities.

Purchase: The company can purchase the site, construct the building, and purchase all store fixtures. The cost would be $1,855,100. An immediate down payment of $415,200 is required, and the remaining $1,439,900 would be paid off over 5 years at $352,500 per year (including interest payments made at end of year). The property is expected to have a useful life of 12 years, and then it will be sold for $508,400. As the owner of the property, the company will have the following out-of-pocket expenses each period.

Property taxes (to be paid at the end of each year)		$40,840
Insurance (to be paid at the beginning of each year)		26,990
Other (primarily maintenance which occurs at the end of each year)		17,390
		$85,220

Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Flint Inc. if Flint will lease the completed facility for 12 years. The annual costs for the lease would be $283,520. Flint would have no responsibility related to the facility over the 12 years. The terms of the lease are that Flint would be required to make 12 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $21,000 is required when the store is opened. This deposit will be returned at the end of the 12th year, assuming no unusual damage to the building structure or fixtures.

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Compute the present value of lease vs purchase. (Currently, the cost of funds for Flint Inc. is 9%.) (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

Answer 1

Ans: Below is the comparison of Purchase option vs. leasing option:

Purchase option
	1	2	3	4	5
Down payment	415,200.00
Yearly Costs (note 1)	287,980.00	287,980.00	287,980.00	287,980.00	287,980.00
Interest	64,520.00	64,520.00	64,520.00	64,520.00	64,520.00
Depreciation	154,592.00	154,592.00	154,592.00	154,592.00	154,592.00
Maintenance cost (including taxes)	85,220.00	85,220.00	85,220.00	85,220.00	85,220.00
Salvage value (Cash inflow)					(508,400.00)
Cash outflow	1,007,512.00	592,312.00	592,312.00	592,312.00	83,912.00
Present value factor (9%)	0.917	0.842	0.772	0.708	0.65
Present value of Cash outflows	923,888.50	498,726.70	457,264.86	419,356.90	54,542.80
TOTAL cash outflows for purchase	$ 2,353,780

Note 1
Total cost	1855100
Less: Down payment	-415200
Balance	1439900
Years	5
Yearly Cost (Balance/no. of years)	287980

Note 2
Payment per year including interest	352500
Payment per year excluding interest	287980
Interest	64520

Note 3
Cost of building	1855100
Useful life	12 years
Depreciation per year (Cost/ useful life)	154592
(Assuming Straight Line Depreciation Method)

Leasing Option
	0	1	2	3	4	5	6	7	8	9	10	11	12
Deposit	21,000.00												(21,000.00)
Annual lease payments		283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00
Cash outflow	21,000.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	283,520.00	262,520.00
Present value factor (9%)	1.00	0.92	0.84	0.77	0.71	0.65	0.60	0.55	0.50	0.46	0.42	0.39	0.36
Present value of Cash outflows	21,000.00	259,987.84	238,723.84	218,877.44	200,732.16	184,288.00	168,977.92	155,085.44	142,327.04	130,419.20	119,645.44	110,005.76	93,457.12
TOTAL cash outflows for leasing	$ 2,043,527

Since leasing has a lower present value of cash outflows, it should be the preferred option