Question

The Flounder 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, Flounder has decided to locate a new factory in the Panama City area. Flounder 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 $610,600, useful life 27 years. Building B: Lease for 27 years with annual lease payments of $70,870 being made at the beginning of the year. Building C: Purchase for $657,200 cash. This building is larger than needed; however, the excess space can be sublet for 27 years at a net annual rental of $6,110. Rental payments will be received at the end of each year. The Flounder Inc. has no aversion to being a landlord. Click here to view factor tables In which building would you recommend that The Flounder Inc. locate, assuming a 12% cost of funds? (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to decimal places, e.g. 458,581.) Net Present Value Building A $ -610600 Building B $ Building C $ The Flounder Inc. should locate itself in

Answer 1

Solution :

Present value of Building A = Cash price of Building = $610,600

Present value of Building B = $70,870 * Cumulative PV Factor at 12% for 27 periods of annuity due

= $70,870 * 8.89566 = $630,435

Present value of Building C = Cash price- Present value of rental income = $657,200 -  $6,110 * Cumulative PV Factor at 12% for 27 periods

= $657,200 - $6,110 * 7.94255 = $608,671

The flounder Inc. should locate itself in Building C.