Question

The Windsor 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, Windsor has decided to locate a new factory in the Panama City area. Windsor 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 $615,000, useful life 28 years.
Building B: Lease for 28 years with annual lease payments of $71,570 being made at the beginning of the year.
Building C: Purchase for $659,900 cash. This building is larger than needed; however, the excess space can be sublet for 28 years at a net annual rental of $6,870. Rental payments will be received at the end of each year. The Windsor Inc. has no aversion to being a landlord.

In which building would you recommend that The Windsor Inc. locate, assuming a 12% 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.)

Building A NPV: $

Building B NPV: $

Building C NPV: $

Answer 1

Solution :

Present value of Building A = Cash price of Building = $615,000

Present value of Building B = $71,570 * Cumulative PV Factor at 12% for 28 periods of annuity due

= $71,570 * 8.94255 = $640,018

Present value of Building C = Cash price- Present value of rental income = $659,900 - $6,870 * Cumulative PV Factor at 12% for 28 periods

= $659,900 - $6,870 * 7.98442 = $605,047

The Windsor Inc. should locate itself in Building C.