Question

The Stellar Inc., a manufacturer of low-sugar, low-sodium, low-cholesterol TV dinners, would like to increase its market share in the Sunbelt. In order to do so, Stellar has decided to locate a new factory in the Panama City area. Stellar will either buy or lease a site depending upon which is more advantageous. The site location committee has narrowed down the available sites to the following three very similar buildings that will meet their needs.

Building A: Purchase for a cash price of $618,100, useful life 26 years.

Building B: Lease for 26 years with annual lease payments of $70,340 being made at the beginning of the year.

Building C: Purchase for $653,200 cash. This building is larger than needed; however, the excess space can be sublet for 26 years at a net annual rental of $6,540. Rental payments will be received at the end of each year. The Stellar Inc. has no aversion to being a landlord.

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In which building would you recommend that The Stellar Inc. locate, assuming a 12% cost of funds? (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

		Net Present Value
Building A		$enter a dollar amount rounded to 0 decimal places
Building B		$enter a dollar amount rounded to 0 decimal places
Building C		$enter a dollar amount rounded to 0 decimal places

The Stellar Inc. should locate itself in

select a building

Answer 1

Net Present Value(NPV) = Present Value of net cash inflow/outfow - Total net Initial Investment.

Present value of cash inflow= F/(1+i)^n

Where F= Future Payment, i= Discount rate, n= number of period in future cash flow

Building A

Present value of net cash inflow is equal to NIL, as tax rate is not given in question, therefore it is assumed that there will be no tax saving due to depreciation.

Initial Investment= $618,100

NPV= ($618,100)

Building B

Cash flow at begining of each year= $70,340 for 26 years

Present value of net cash outflow= $70,340 + $70,340PVAF(12%. 25 Years)

= $70340+ $70,340*7.8431

= $70,340+ $551,684

= $622,024

NPV of Building B= ($622,024)   

Building C

Initial Investment= $653,200

Cash inflow at end of each year= $6,540 for 26 years

Present value of cash inflow= $6540PVAF(12%, 26Years)

=$6540*7.8956

=$51,637

NPV of Building C= $51,637 - 653200

= ($601,563)

NPV of Building C is ($601,563) is least in terms of net cash outflow, therefore Building C should be selected.