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. Cash flows for owning versus leasing are estimated as follows. Assume that the cash flows from operations will remain level over a 10 year holding period. If purchased, the company will invest $355,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due in year 10. The after-tax cash flow from sale of the property at the end of year 10 is expected to be $850,000. What is the incremental rate of return on equity to the company, if the property is owned 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:	​	​
Business	130,000	130,000
Real estate	60,000	60,000
Lease payments	0	120,000
Interest	90,000	0
Depreciation	35,000	0
Taxable income	185,000	190,000
Tax	55,500	57,000
Income after tax	129,500	133,000
Plus: Depreciation	35,000	0
After-tax cash flow	164,500	133,000

Answer 1