Question

NPV AND IRR

A store has 5 years remaining on its lease in a mall. Rent is $2,100 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).

Should the new lease be accepted? (Hint: Be sure to use 1% per month.)
yes/no

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

For question 1, we will be calculating cash flow and consequently, present value of old lease and new lease.

Now, present value can be calculated using the formula -

For old lease: P = 2100

r = 1%

n = 60 months

Hence, using the above formula, we get value as $94,405.58

For new lease, we have

P = 2700

r = 1%

n = 51 months

hence, using the above formula we get $107,455.97

However, this present value after nine months of term, hence we will have to discount it for nine months. So, the present value for new lease after discounting for nine months is

= (107,455.97) / ((1+.01)^9)

= 98,250.36

As the present value for new lease is higher than old lease, it cannot be accepted by the store

For 2nd question

We will find the lease payment at which present value of new lease payment is equivalent to lease payment of old lease (i.e. = 94,405.58)

For this, we will first find the future value this lease after nine months using the formula

FV = 94,405.58 * (1+1%)^9 = 103,249.99

Now we will find out the payment required to have this value as Present value for new lease (for 51 months)

Payment = (PV * r) / (1-(1+r)^-n))

Payment = (103,249.99)/ (1-(1+1%)^-51) = 2594.34 (at this lease payment, store will be indifferent)

For 3rd question

We need to take the difference of total cash flow for each month and then calculating IRR

Hence, for 9 months the old lease payment will 2100 and new lease payment will be 0

and for next 51 months the difference between two lease payments will be -600

Hence, the IRR for this cash flow using excel turns out to be 1.7222%