Question

A store has 5 years remaining on its lease in a mall. Rent is $2,000 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 $2,700 per month for the next 51 months. The lease cannot be broken, and the store's WACC is 12% (or 1% per month).

1. Should the new lease be accepted? (Hint: Be sure to use 1% per month.)
   
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3. 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.
   
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5. 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.
   
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Answer 1

a)   since the PV of the proposed rent is Higher than the PV of existing rent, the lease should not be accepted

to know whether the lease is acceptable we need to find the PV of the rental outflows of each option

we know,  

    

p- periodic payment, r-rate of interest, n-number of payments

PV of current Rental outflows  

rent    P    = 2000

rate     r    =12% p.a or 1% per month or 0.01

          n = 60 months

  

          

           

           

PV of proposed rentals

rent    P    = 2700

rate     r    =12% p.a or 1% per month or 0.01

          n = 51 months

        

         

          

But this is the PV as at the 9th month.. so to determine its PV as of now,

   we know,

       PV     =   1FV / (1+r)ⁿ

       PV     =   107454.97 / (1+0.01)⁹      

                   = $ 98,250.36

since the PV of the proposed rent is Higher ($98,250.36) than the PV of existing rent ($89,910.07), the lease should not be accepted

     b)      store owner can bargain for a rent of $ 2470.80 per month- since the PV of this and the PV of the existing rent of $ 2000it would be same

the price at which -both options give the same PV would be the indifference point

PV of current rent of 2000 = 89,910.07

The future value of this at 9th month =   PV (1+r)n

                                                       = 89910.07(1+0.01)⁹

                                                                        =98333.33

so, the rent at which the proposed rent's PV equals 98333.33 will be the indifference rent. i.e.

      let the desired rent be P.   PV of this rent is   =

       

at indifference point,

                    

                     

               p     =     98333.33 / 39.79813617

                      = $ 2470.80

Store owner can bargain for a rent of $ 2470.80 per month- since the PV of this and the PV of the existing rent of $ 2000it would be same

c)   The WACC at which the store would be indifferent is 2.53%

the rate at which two options give the same NPV would be the incremental IRR. Incremental IRR is the IRR between the incremental cash flows from two options. They are computed as below.

excel formulas are