Homework SourseSandhill Inc owns and operates a number of hardware stores i
Sandhill 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 $1,851,000. An immediate down payment of $408,200 is required, and the remaining $1,442,800 would be paid off over 5 years at $354,300 per year (including interest payments made at end of year). The property is expected to have a useful life of 11 years, and then it will be sold for $509,600. As the owner of the property, the company will have the following out-of-pocket expenses each period.
$40,770
27,130
16,830
$84,730
Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Sandhill Inc. if Sandhill will lease the completed facility for 11 years. The annual costs for the lease would be $292,340. Sandhill would have no responsibility related to the facility over the 11 years. The terms of the lease are that Sandhill would be required to make 11 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $71,300 is required when the store is opened. This deposit will be returned at the end of the 11th 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 Sandhill Inc. is 10%.) (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)
Present Value Lease?
Present Value Purchase?
| Property taxes (to be paid at the end of each year) | $40,770 | |
| Insurance (to be paid at the beginning of each year) | 27,130 | |
| Other (primarily maintenance which occurs at the end of each year) | 16,830 | |
| $84,730 |
Solution
PV of Lease = [Annual Lease Payment*PVAF(10%,11)(beginn.)]-Deposit+[Deposit return*PVF(10%,11)]
= ($292,340*7.14457)-$71,300+($71,300*0.35049)
= $2,088,644-$71,300+$24,990 = $2,042,333.53 or $2,042,334
Present Value of Purchase is calculated as follows:-
As the present value of lease of $2,042,334 is less than present value of purchase of $2,140,614, the company should lease the property.
| Down payment | $408,200 |
| Add: PV of Annual payments over 5 years [Annual payments*PVAF(5 yrs, 10%)] | |
| ($354,300*3.79079) | 1,343,077 |
| Add: PV of property taxes and maintenance [($40,770+$16,830)*PVAF(10%, 11)] = ($57,600*6.49506) | 374,115 |
| Add: PV of Insurance ($27,130*7.14457) | 193,832 |
| Less: PV of sale of property at the end ($509,600*0.0.35049) | (178,610) |
| Present Value of Purchase | 2,140,614 |
