Question

Pharoah Inc. owns and operates a number of hardware stores in the Atlantic region. Recently, the company has decided to open another store in a rapidly growing area of Nova Scotia. The company is trying to decide whether to purchase or lease the building and related facilities. Currently, the cost of funds for Pharoah Inc. is 10%. Purchase: Lease: The company can purchase the site, construct the building, and purchase all store fixtures. The cost would be $1,990,000. An immediate down payment of $400,000 is required, and the remaining $1,590,000 would be paid off over five years with payments of $378,000 per year (including interest payments made at the end of the year). The property is expected to have a useful life of 12 years, and then it will be sold for $600,000. As the owner of the property, the company will pay $55,000 in occupancy expenses at the end of each year. First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Pharoah Inc. if Pharoah will lease the completed facility for 12 years. The annual payments would be $322,000. Pharoah would have no responsibility related to the facility over the 12 years. The terms of the lease are that Pharoah would be required to make 12 annual payments. (The first payment is to be made at the time the store opens and then one each following year.) In addition, a deposit of $105,000 is required when the store is opened. This deposit will be returned at the end of the twelfth year, assuming there is no unusual damage to the building structure or fixtures. Assume a 10% discount rate. Using factor tables, calculate the present value of the net cash flows required of Pharoah Inc. for: (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answers to o decimal places, e.g. 5,275.) Click here to view the factor table PRESENT VALUE OF 1. Click here to view the factor table PRESENT VALUE OF AN ANNUITY OF 1. Present Value 1. The purchase alternatives 2. The lease alternative $ LINK TO TEXT LINK TO TEXT Which of the two alternatives should Pharoah Inc, adopt? Pharoah Inc. should adopt th alternative. lease purchase

Answer 1

Solution:

Computation of Present Value of Purchasing and Leasing option - Pharoah Inc.
Particulars	Period	Amount	PV Factor	Present Value
Purchasing Option:
Down payment	0	$400,000.00	1.00000	$400,000
Annual installment	1-5	$378,000.00	3.79079	$1,432,919
Occupancy expenses	1-12	$55,000.00	6.81369	$374,753
Sale Value of building	12	-$600,000.00	0.31863	-$191,178
Present Value of Buying Option (A)				$2,016,494
Leasing Option:
Annual lease payment	0-11	$322,000.00	7.49506	$2,413,409
Security deposit	0	$105,000.00	1.00000	$105,000
Return of Security deposit	12	-$105,000.00	0.31863	-$33,456
Present Value of Leasing Option (B)				$2,484,953

Pharoah Inc. should adopt the purchase alternative.