Question

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

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

b- 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.

c- 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

Part - a

Under old Lease Scheme
Monthly Cash Inflow	$1900
Period of Lease	60 Months
WACC	1% per Month
PV Factor for 1%p.m for 60 Months	44.955
Present Value of Lease    =	Monthly Rent * PV factor @1% for 60 Months
=	1900 * 44.955
=	85,414.50
Under New Lease Scheme
Monthly Cash Inflow For 1 to 9 Months	NIL
Monthly Cash Inflow for 10 to 60 Months	$2600
Period of Lease	51 Months
WACC	1% per Month
PV Factor for 1%p.m for 10 to 60 Months	36.389
Present Value of Lease    =	Monthly Rent * PV factor @1% for 10 to 60 Months
=	2600 * 44.955
=	94,611.45
Answer : New Lease should be accepted as NPV under new Scheme is higher than NPV under Old Scheme. Part b

At indifferent Point,
NPV under Old Scheme      =              NPV under New Scheme
Monthly Rent * PV factor @1% for 60 Months         =	Monthly Rent * PV factor @1% for 10 to 60 Months
1900 * 44.955    =	Monthly Rent * 36.389
Monthly Rent =	1900 * 44.955 / 36.389
	2,347.26
Monthly rent should be $ 2347.26 Part C At indifferent Point, NPV under Old Scheme      =              NPV under New Scheme Monthly Rent * PV factor @1% for 60 Months         =            Monthly Rent * PV factor @IRR% for 10 to 60 Months 1900 * 44.955    = 2600 * X Monthly Rent = 1900 * 44.955 / 2600 32.85 By Using Interpolation, PV Factor for 1.32%p.m for 10 to 60 Months                                                                                              45.889 So WACC = 1.32 % p.m. or say 15.84% p.a. 15.84