Question

The Porter Beverage Factory owns a building for its operations. Porter uses only half of the building and is considering two options for the unused space. The Popcorn Store would like to purchase the half of the building that is not being used for $605,000. A 8% commission would have to be paid at the time of purchase. Salty Snacks would like to lease the half of the building for the next 5 years at $159,700 each year. Stewart would have to continue paying $52,900 of property taxes each year and $10,100 of yearly insurance on the property, according to the proposed lease agreement.

Determine the differential income or loss from the lease alternative. Enter a loss as a negative number.

Answer 1

Solution

Porter Beverage Factory

Alternative 1 –

Sale to Popcorn Store

Sale value = $605,000

Less: 8% commission = $48,400

Net proceeds from sale of half of property = $556,600

Alternative 2:

Lease to Salty Snacks

Annual lease payments = $159,700

Less: property taxes $52,900

Insurance $10,100

Net income from leasing half of the property = 159,700 – (52,900 – 10,100) = $96,700

Differential income or (loss) from lease alternative = $556,600 – 96,700 = ($459,900)

Hence, lease alternative results in a differential loss of $459,900 compared to the alternative of sale.

Other Considerations –

1. Lease payments are to be discounted at the borrowing rate, which would further reduce the annual value of lease payments.
2. However, lease is not a sale and the property still remains with Porter Beverage Factory and would likely generate further income.
3. The net sale proceeds from the property, $556,600 is immediate cash flow to the company.