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 $2,500 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.

Answer 1

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%