Question

Flounder 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 $1,861,400. An immediate down payment of $406,400 is required, and the remaining $1,455,000 would be paid off over 5 years at $354,200 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 $508,400. As the owner of the property, the company will have the following out-of-pocket expenses each period.

Property taxes (to be paid at the end of each year)    $41,860

Insurance (to be paid at the beginning of each year) 26,960

Other (primarily maintenance which occurs at the end of each year) 17,170

   $85,990

Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Flounder Inc. if Flounder will lease the completed facility for 12 years. The annual costs for the lease would be $266,320. Flounder would have no responsibility related to the facility over the 12 years. The terms of the lease are that Flounder would be required to make 12 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $104,900 is required when the store is opened. This deposit will be returned at the end of the 12th 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 Flounder Inc. is 11%.)

Answer 1

Compute the present value of lease vs purchase. (Currently, the cost of funds for Flounder Inc. is 11%.)
Present value of net purchase costs:
Down payment	$   4,06,400.00
Present value of Installments ( $354,200 x PVOA(11%,5)	$ 13,09,087.78
Present Value of Property taxes and other costs (41860 + 17170) x PVOA(11%,12)	$   3,83,246.37
Present value of insurance = 26960 x PVAD(11%,12)	$   1,94,287.78
Total costs	$ 22,93,021.93
Less: Salvage value = $508,400 x PV(11%,12)	$   1,45,321.06
Net costs	$ 21,47,700.88
Cost for leasing
Present Value of lease payments = $266,320 x PVAD(11%,12)	$ 19,19,240.41
Present Value of Interest lost on the deposit per year  $104,900 x 11%  x PVOA(11%,12)	$      74,915.80
Cost for leasing the facilities	$ 19,94,156.21
Flouder Inc. should lease the facilities because the present value of the costs for leasing the facilities, $1994156.21, is less than the present value of the costs for purchasing the facilities, $2147,700.88