Question

A company is planning to move to a larger office and is trying to decide if the new office should be owned or leased.  Information about cash flows for owning versus leasing is provided as follows.  Assume that the cash flows from operations will remain the same level over a 10-year holding period.  If purchased, the company will invest $385,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due when the property is sold.  The after-tax cash flow from sale of the property at the end of year 10 is expected to be $750,000.  What is the incremental rate of return on equity to the company, if the property is owned for 10 years instead of leased?

	Own	Lease
Sales	1,000,000	1,000,000
Cost of goods sold	500,000	500,000
Gross income	500,000	500,000
Operating expenses:	190,000	190,000
Lease payments	0	120,000
Interest	90,000	0
Depreciation	35,000	0
Taxable income	185,000	190,000
Ordinary Income tax	55,500	57,000

	a.	13.26%
	b.	12.62%
	c.	17.99%
	d.	10.32%

Answer 1

Answer is a) 13.26%