Question

Blue 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 $1,864,500. An immediate down payment of $410,900 is required, and the remaining $1,453,600 would be paid off over 5 years at $355,800 per year (including interest payments made at end of year). The property is expected to have a useful life of 11 years, and then it will be sold for $505,800. 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)		$40,940
Insurance (to be paid at the beginning of each year)		27,090
Other (primarily maintenance which occurs at the end of each year)		16,120
		$84,150

Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Blue Inc. if Blue will lease the completed facility for 11 years. The annual costs for the lease would be $269,240. Blue would have no responsibility related to the facility over the 11 years. The terms of the lease are that Blue would be required to make 11 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $97,900 is required when the store is opened. This deposit will be returned at the end of the 11th 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 Blue Inc. is 10%.) (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 Blue Inc. follow?

Blue Inc. should leasepurchase the facilities

Answer 1

1. PV of cashflows under Purchases:

Year	Towards asset	Out of pocket expense	Residual Value	Total	Discount factor @ 10%	Discounted Cashflows
0	-410900			-410900	1.0000	(410,900.00)
1	-355800	-84150		-439950	0.9091	(399,954.55)
2	-355800	-84150		-439950	0.8264	(363,595.04)
3	-355800	-84150		-439950	0.7513	(330,540.95)
4	-355800	-84150		-439950	0.6830	(300,491.77)
5	-355800	-84150		-439950	0.6209	(273,174.34)
6		-84150		-84150	0.5645	(47,500.48)
7		-84150		-84150	0.5132	(43,182.26)
8		-84150		-84150	0.4665	(39,256.60)
9		-84150		-84150	0.4241	(35,687.81)
10		-84150		-84150	0.3855	(32,443.47)
11		-84150	505800	421650	0.3505	147,785.75
					PV of Cashflows	(2,128,941.50)

2. PV of cashflows under Leasing:

Year	Cashflows	Discount Factor @ 10%	Discounted Cashflows
0	-97900 (deposit made)	1.0000	-97900.00
0	-269240	1.0000	-269240.00
1	-269240	0.9091	-244766.08
2	-269240	0.8264	-222499.94
3	-269240	0.7513	-202280.01
4	-269240	0.683	-183890.92
5	-269240	0.6209	-167171.12
6	-269240	0.5645	-151985.98
7	-269240	0.5132	-138173.97
8	-269240	0.4665	-125600.46
9	-269240	0.4241	-114184.68
10	-269240	0.3855	-103792.02
11	97900 (depsoi received back)	0.3505	34313.35
		PV of Cashflows	-1987171.83

So,

1.

	Leasing	Purchases
Present Value	-1987172	-2128942

2. Blue Inc. should LEASE the facilities are the PV of Cash outflows are lesser.