Question

Problem 5 Brubaker Inc., is considering buying or leasing a site for its manufacturing operations depending on which is more advantageous. They are considering three options: Building A: Purchase for a cash price of $600,000, payable immediately. This building will have a useful life of 20 years, and can be sold for $60,000 in cash at the end of 20 years. Building B: Lease for 20 years with annual lease payments of $70,000 payable at the beginning of each year. Building C: Purchase for $640,000 cash immediately. This building is larger than needed; however, the excess space can be sublet for 20 years at a net annual rental of $8,000. Rental payments will be received at the end of the year. At the end of 20 years, the building can be sold for $70,000 in cash. Required: In which building would you recommend that Brubaker, Inc. locate, assuming a 12% cost of funds? Ignore tax implications. Show calculations.

Answer 1

cost of capitai = 12%

Building A

PV of cash outflow= 600000.

PV of cash inflow= PVIF x sales revenue

= .103 x 60000= 6220

Cost = 600000-6220= 593780

Building B

PV of cash outflow= PVIFA x Lease payment

= 7.366 x 70000= 515604

Building C

PV of cash outflow= 640000

PV of cash inflow= PVIFA x Rental income + PVIF x Sales revenue

= 7.469 x 8000 + .103 x 70000

= 59755+ 7257= 67012

Cost = 640000-67012= 572988

Building B has the lowest cost so is more preferable.