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 $2,600 per month for the next 51 months. The lease cannot be broken, and the store's WACC is 12% (or 1% per month). Should the new lease be accepted? 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? f 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?

Answer 1

In the scenario where Rent is $2000 for 60 months:

Present value of cash inflows at WACC of 12% = $2000/(1.01)^1 + $2000/(1.01)^2 + $2000/(1.01)^3 +........+ $2000/(1.01)^60 = $89,910

Now take the scenario where Rent is $2600 for 51 months starting after 9 months

Present value of cash inflows at WACC of 12% = $2600/(1.01)^10 + $2600/(1.01)^11 + $2600/(1.01)^12 +........+ $2600/(1.01)^60 = $94,611

Present value of second scenario is more than first scenario so the owner should prefer to choose - The new lease which calls for no rent for 9 months, then payments of $2,600 per month for the next 51 months.

Now in above scenarios we assumed WACC of 12%, the next question is at what WACC the decision is indifferent

by hit and trial we get WACC = ~23.9% as at discount rate of 23.9% present value of both rents are same

Another question is at what increased rent the decision remains unchanged:

by hit and trial and interpolation we get = $2469