Question

Exercise 6-12

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 $616,000, useful life 26 years.

Building B: Lease for 26 years with annual lease payments of $70,880 being made at the beginning of the year.

Building C: Purchase for $650,600 cash. This building is larger than needed; however, the excess space can be sublet for 26 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.

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In which building would you recommend that The Flounder Inc. locate, assuming a 10% cost of funds? (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

Answer 1

The option with the lowest present value of cost today will be chosen

Building A = $616000

Building B = 70880+70880*PVAF(10%, 25 years)

= 70880 + 70880*9.07704

= $714,261

Building C = 650600 – 6110*PVAF(10%, 26 years)

= 650600 – 6110*9.16095

= $594,627

Hence, Building C should be chosen