Question

In: Accounting

The Indigo Inc., a manufacturer of low-sugar, low-sodium, low-cholesterol TV dinners, would like to increase its...

The Indigo 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, Indigo has decided to locate a new factory in the Panama City area. Indigo 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 $610,000, useful life 27 years. Building B: Lease for 27 years with annual lease payments of $70,500 being made at the beginning of the year. Building C: Purchase for $656,700 cash. This building is larger than needed; however, the excess space can be sublet for 27 years at a net annual rental of $6,570. Rental payments will be received at the end of each year. The Indigo Inc. has no aversion to being a landlord. Click here to view factor tables In which building would you recommend that The Indigo Inc. locate, assuming a 10% 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 $Entry field with correct answer Building B $Entry field with incorrect answer Building C $Entry field with correct answer The Indigo Inc. should locate itself in Entry field with correct answer

Solutions

Expert Solution

1 In case of purchase of building for cash price of $610000 with useful life of 27 years. Payment is to be made upfront

Thus net present value of building cost will be the payment made for acquisition of building itself.

Thus net present value of building = ($610000).

2 . In case of lease of building annual lease payment is to be made every year @ $70500 for 27 years but at the beginning of the year .

Accordingly Net present value of the building = 70500+70500xpvaf(10%,26 years)

= 70500+70500x9.16095

= 70500+645847

=($716347).

Thus, in case of lease Net present value = ($716347)

3 . In case of purchase of a larger building

NPV = upfront payment - annual rental x pvaf (10%,27 years)

= 656700 - 6570x9.23722

= 656700-60689

= $596011.

Thus , NPV in case of larger building = ($596011).

Since lowest net present value of expense is of larger building, thus we should buy larger building of $656700 and sublet unused portion of the building


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