Question

Problem 6-10

Splish 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 $1,867,900. An immediate down payment of $402,100 is required, and the remaining $1,465,800 would be paid off over 5 years at $351,600 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 $510,600. 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)		$40,790
Insurance (to be paid at the beginning of each year)		27,310
Other (primarily maintenance which occurs at the end of each year)		16,330
		$84,430

Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Splish Inc. if Splish will lease the completed facility for 12 years. The annual costs for the lease would be $263,970. Splish would have no responsibility related to the facility over the 12 years. The terms of the lease are that Splish 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 $107,900 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 Splish Inc. is 11%.) (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

	Lease		Purchase
Present value	$		$

Which of the two approaches should Splish Inc. follow?

Splish Inc. should leasepurchase the facilities

Answer 1

Solution:

Computation of Present Value of Purchasing and Leasing option - Splish Inc.
Particulars	Period	Amount	PV Factor	Present Value
Purchasing Option:
Down payment	0	$402,100.00	1.00000	$402,100
Annual installment	1-5	$351,600.00	3.69590	$1,299,478
Property taxes	1-12	$40,790.00	6.49236	$264,823
Insurance	0-11	$27,310.00	7.20652	$196,810
Others	1-12	$16,330.00	6.49236	$106,020
Sale Value of building	12	-$510,600.00	0.28584	-$145,950
Present Value of Buying Option (A)				$2,123,282
Leasing Option:
Annual lease payment	0-11	$263,970.00	7.20652	$1,902,305
Security deposit	0	$107,900.00	1.00000	$107,900
Return of Security deposit	12	-$107,900.00	0.28584	-$30,842
Present Value of Leasing Option (B)				$1,979,363

splish Inc, should lease the faciliites.