Question

B С D F G VCC Case Study #2 Early in the year 2005, the owner of a building made a lessee an offer. The lease contract has four more years to run, and the rent is to be increased by 10% a year each year over the preceding year. The rent is payable in equal monthly installments but (for the sake of simplicity) assume it is all paid at year-end. The building owner's offer is that a lump sum payment now (early in January 2005 before the January rent check had been prepared) of $80,000 would be considered as prepaid rent for the remaining four years of the contract. If the offer is accepted, Charlie would borrow $80,000 from the bank. The arrangement with the bank is that $20,000 of the principal will be repaid on December 31, of the years 2005 through 2008, with interest at 12% on the amount owed at the beginning of each year. Use the interest rate as the discount rate. The tax rate is 22%. Assume that in 2004, the rent payment was $24,000. Should the offer be accepted? Sheet1 Sheet2 Sheet3 +) Type here to search O TT

Answer 1

			1	2	3	4
1. Calculation of Net Present Value of Rent Outflows		Total Net Present Value of Out Flow
Year / Particulars		2004	2005	2006	2007	2008
Rent	A	$24,000	$26,400	$29,040	$31,944	$35,138
Tax Deduction @22%	B		$5,808	$6,389	$7,028	$7,730
Net payment	C = A - B		$20,592	$22,651	$24,916	$27,408
Present Value Factor @ 12%	D		0.8929	0.7972	0.7118	0.6355
Present of Value of Net Outflow	E = C * D		$18,386	$18,057	$17,735	$17,418		$71,596
2. Calcultion of Net Present Value of Cash Flow if Purchase offer accepted with Bank Borrowing Payment
Year / Particulars		2004	2005	2006	2007	2008
Principal Outstanding at Beginning	A		$80,000	$60,000	$40,000	$20,000
Interest	B		$9,600	$7,200	$4,800	$2,400
Tax Benefit @ 22%	C = B *22%		$1,152	$864	$576	$288
Principal Payment Fixed @ 20000 P.a	D		$20,000	$20,000	$20,000	$20,000
Closing Oustanding	E = A - D		$60,000	$40,000	$20,000	$0
Net Cash Out Flow	F = B - C + D		$28,448	$26,336	$24,224	$22,112
Present Value Factor @ 12%	G		0.8929	0.7972	0.7118	0.6355
Present of Value of Net Outflow	H = F * G		$25,400	$20,995	$17,242	$14,053		$77,690
Conclusion
1. on the Basis of Above calculation the lessee should not accept the offer made by Lessor.