James Kirk is a financial executive with Kingbird Enterprises. Although James Kirk has not had any formal training in finance or accounting, he has a “good sense” for numbers and has helped the company grow from a very small company ($534,000 sales) to a large operation ($48,060,000 in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which James Kirk feels a little “over his head.” He therefore has decided to hire a new employee with “numbers” expertise to help him. As a basis for determining whom to employ, he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently. Here are the questions.
n 2019, Kingbird Enterprises negotiated and closed a long-term
lease contract for newly constructed truck terminals and freight
storage facilities. The buildings were constructed on land owned by
the company. On January 1, 2020, Kingbird took possession of the
leased property. The 20-year lease is effective for the period
January 1, 2020, through December 31, 2036. Advance rental payments
of $859,000 are payable to the lessor (owner of facilities) on
January 1 of each of the first 10 years of the lease term. Advance
payments of $433,000 are due on January 1 for each of the last 10
years of the lease term. Kingbird has an option to purchase all the
leased facilities for $1 on December 31, 2036. At the time the
lease was negotiated, the fair value of the truck terminals and
freight storage facilities was approximately $7,708,000. If the
company had borrowed the money to purchase the facilities, it would
have had to pay 10% interest.
Compute the present value of lease vs purchase. (Round
factor values to 5 decimal places, e.g. 1.25124 and final answer to
0 decimal places, e.g. 458,581.)
PURCHASE OPTION | |||||
Cost of facilities | $7,708,000 | ||||
LEASE OPTION | |||||
Present Value of Cash Flow: | |||||
(Cash Flow)/((1+i)^N) | |||||
i=discount rate =cost of debt =10%=0.1 | |||||
N=Year of cash flow | |||||
Year | Cash flow | Present Value | |||
0 | $859,000 | $859,000 | |||
1 | $859,000 | $780,909 | |||
2 | $859,000 | $709,917 | |||
3 | $859,000 | $645,379 | |||
4 | $859,000 | $586,709 | |||
5 | $859,000 | $533,371 | |||
6 | $859,000 | $484,883 | |||
7 | $859,000 | $440,803 | |||
8 | $859,000 | $400,730 | |||
9 | $859,000 | $364,300 | |||
10 | $433,000 | $166,940 | |||
11 | $433,000 | $151,764 | |||
12 | $433,000 | $137,967 | |||
13 | $433,000 | $125,425 | |||
14 | $433,000 | $114,022 | |||
15 | $433,000 | $103,657 | |||
16 | $433,000 | $94,233 | |||
17 | $433,000 | $85,667 | |||
18 | $433,000 | $77,879 | |||
19 | $433,000 | $70,799 | |||
20 | $1 | $0.1486 | |||
SUM | $6,934,355 | ||||
Present Value of Lease | $6,934,355 | ||||
Present Value of Purchase | $7,708,000 | ||||
NOTE: Since data on tax and depreciation are not given, these are ignored | |||||
Purchase option will have benefit of interest tax shield and depreciation tax shield | |||||
James Kirk is a financial executive with Kingbird Enterprises. Although James Kirk has not had any...
James Kirk is a financial executive with Kingbird Enterprises. Although James Kirk has not had any formal training in finance or accounting, he has a “good sense” for numbers and has helped the company grow from a very small company ($534,000 sales) to a large operation ($48,060,000 in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which James Kirk feels a little “over his head.” He therefore has decided...
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Problem 6-9 James Kirk is a financial executive with Flounder Enterprises. Although James Kirk has not had any formal training in finance or accounting, he has a "good sense" for numbers and has helped the company grow from a very small company ($540,000 sales) to a large operation ($48,600,000 in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which James Kirk feels a little "over his head." He therefore...
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