Question

I'm having trouble with the problem below.

Grouper 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 $1,862,300. An immediate down payment of $417,600 is required, and the remaining $1,444,700 would be paid off over 5 years at $354,700 per year (including interest payments made at end of year). The property is expected to have a useful life of 12 years, and then it wll be sold for $505,700. As the owner of the property, the company will have the following out-of-pocket expenses cach period Property taxes (to be paid at the end of each year) Insurance (to be paid at the beginning of each year) Other (primarily maintenance which occurs at the end of each year) $40,880 26,660 16,950 $84,490 Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate foxtures for Grouper Inc. if Grouper will lease the completed facility for 12 years. The annual costs for the lease would be $249,060. Grouper would have no responsibility related to the facility over the 12 years. The terms of the lease are that Grouper would be required to make 12 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $108,700 is required when the store is opened. This deposit will be returned at the end of the 12th year, assuming no unusual damage to the building structure or fixtures. Compute the present value of lease vs purchase. (Currently, the cost of funds for Grouper Inc. is 9%) (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 2988720 1862300 Which of the two approaches should Grouper Inc. follow? Grouper Inc. should laass the focilities

Answer 1

As can be seen from the below calculations, it is better to lease as it will save $225,539 compared to Purchase option.

Present Value of Net Purchase cost Down Payment Installments Property Taxes & other cost Insurance Total Cost Less: Salvage Value Net Costs Amount Calculation 4,17,600 13,79,783 354700*3.890 4,14,121 (40880+16950)*7.161 2,08,081 26660*7.80519 24,19,585 1,80,029 505700 *0.356 22,39,556 Present Value of Leasing Option Present Value of Lease Rent (A Interest lost on deposit Present Value of Interest lost on deposit (B) Net Costs (A) (B Amount Calculation 19,43,961 2490607.80519 9,783 1108700*9% 70,056 9783 7.161 20,14,017