Question

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 $2,700 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?

2. 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.)

3. 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.)

Answer 1

a.

Clearly, PV of 1900 payments for 60 months is less than PV of 2700 payments for 51 months. Hence old lease is a better option.

b.

Hence, the new payment should be 2,347.26 for rent payer to be indifferent.

c.

The difference between two payments are from 1 to 9 Payments = -1900
from 10 to 60 payments = 2700-1900 = 800

3.32% is monthly IRR. Annual Rate = 3.32%*12 = 39.84%

Hence, at 39.84% both the options are indifferent.

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