Question

P6-10 (Analysis of Lease vs. Purchase) Dunn 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 fi xtures.
The cost would be $1,850,000. An immediate down payment of $400,000 is required, and the remaining
$1,450,000 would be paid off over 5 years at $350,000 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 will be sold for $500,000. As the
owner of the property, the company will have the following out-of-pocket expenses each period.

Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate
fi xtures for Dunn Inc. if Dunn will lease the completed facility for 12 years. The annual costs for
the lease would be $270,000. Dunn would have no responsibility related to the facility over the 12 years.
The terms of the lease are that Dunn would be required to make 12 annual payments (the fi rst payment
to be made at the time the store opens and then each following year). In addition, a deposit of $100,000 is
required when the store is opened. This deposit will be returned at the end of the twelfth year, assuming
no unusual damage to the building structure or fixtures.

cost of funds is 10%

Answer 1

Present Value:

Cost of Buying = Down payment + Pv of Annual Installment Payment + PV of Annual property tax & other primary maintenance payment + PV of Annual Insurance Payment - pv of sale value

Cost of Buying = 400000 + 350000*(1-(1+10%)^-5)/10% + (40000+16000)*(1-(1+10%)^-12)/10% + 27000*(1-(1+10%)^-12)/10% * (1+10%) - 500000/(1+10%)^12

Cost of Buying = $ 2,151,393.50

Present Value of :

Cost of Leasing = Initial Deposit + PV of annual lease payment - pv of deposit refund

Cost of Leasing = 100000+  270000*(1-(1+10%)^-12)/10% * (1+10%) - 100000/(1+10%)^12

Cost of Leasing = $ 2,091,803.39

Decision : The Company should take the building on lease as its present value of cost is lower than buying