A store has 5 years remaining on its lease in a mall Rent is

A store has 5 years remaining on its lease in a mall. Rent is $1,900 per month, 60 payments remain, and the next payment is due in 1 month. The mall\'s owner plans to sell the property in a year and wants rent at that time to be high so that the property will appear more valuable. Therefore, the store has been offered a \"great deal\" (owner\'s words) on a new 5-year lease. The new lease calls for no rent for 9 months, then payments of $2,500 per month for the next 51 months. The lease cannot be broken, and the store\'s WACC is 12% (or 1% per month).

If the store owner decided to bargain with the mall\'s owner over the new lease payment, what new lease payment would make the store owner indifferent between the new and old leases? (Hint: Find FV of the old lease\'s original cost at t = 9; then treat this as the PV of a 51-period annuity whose payments represent the rent during months 10 to 60.) Round your answer to the nearest cent. Do not round your intermediate calculations.

The store owner is not sure of the 12% WACC—it could be higher or lower. At what nominal WACC would the store owner be indifferent between the two leases? (Hint: Calculate the differences between the two payment streams; then find its IRR.) Round your answer to two decimal places. Do not round your intermediate calculations.

Solution

Old Lease Rent = PMT per month $1,900 Payments Remaining 60 Cost of capital 12%/12 1.00% Present value of lease = PV(1%,60,-1900) $85,414.57 New Lease Rent = PMT per month $2,500 Period = no rent for 9 months = 60-9 51 Cost of capital 12%/12 1.00% Present value of lease = calculated using NPV function in excel = NPV (1%payments) $90,972.55 $5,557.98 The store owner should not accept the new lease because the present value of its cost is $90972.55 - $85,414.57 = $5,557.98 greater than the old lease NO b) FV of first 9 months’ rent under old lease: Old Lease Rent = PMT per month $1,900 Payments Remaining 9 Cost of capital 12%/12 1.00% Future value of lease = FV(1%,60,-1900) $17,800.2 The FV of the first 9 months’ rent is equivalent to the PV of the 51-period annuity whose payments represent the incremental rent during months New leases Present Value $17,800.2 Nper 51 Rate 1.00% New leases payment = PMT(1%,51,-17,8002) $447.26 The new lease payment that will make her indifferent is $1900 + $447.26 $2,347.26 c) IRR (calculated using IRR function in excel) Periodic IRR = 2.11% Annual IRR = 2.11% x 12 25.36% Year Old Lease payments New Lease Payments Difference 0 0 0 0 1 -1900 0 -1900 2 -1900 0 -1900 3 -1900 0 -1900 4 -1900 0 -1900 5 -1900 0 -1900 6 -1900 0 -1900 7 -1900 0 -1900 8 -1900 0 -1900 9 -1900 0 -1900 10 -1900 -2500 600 11 -1900 -2500 600 12 -1900 -2500 600 13 -1900 -2500 600 14 -1900 -2500 600 15 -1900 -2500 600 16 -1900 -2500 600 17 -1900 -2500 600 18 -1900 -2500 600 19 -1900 -2500 600 20 -1900 -2500 600 21 -1900 -2500 600 22 -1900 -2500 600 23 -1900 -2500 600 24 -1900 -2500 600 25 -1900 -2500 600 26 -1900 -2500 600 27 -1900 -2500 600 28 -1900 -2500 600 29 -1900 -2500 600 30 -1900 -2500 600 31 -1900 -2500 600 32 -1900 -2500 600 33 -1900 -2500 600 34 -1900 -2500 600 35 -1900 -2500 600 36 -1900 -2500 600 37 -1900 -2500 600 38 -1900 -2500 600 39 -1900 -2500 600 40 -1900 -2500 600 41 -1900 -2500 600 42 -1900 -2500 600 43 -1900 -2500 600 44 -1900 -2500 600 45 -1900 -2500 600 46 -1900 -2500 600 47 -1900 -2500 600 48 -1900 -2500 600 49 -1900 -2500 600 50 -1900 -2500 600 51 -1900 -2500 600 52 -1900 -2500 600 53 -1900 -2500 600 54 -1900 -2500 600 55 -1900 -2500 600 56 -1900 -2500 600 57 -1900 -2500 600 58 -1900 -2500 600 59 -1900 -2500 600 60 -1900 -2500 600 IRR 2.11%