Question

The Stellar 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, Stellar has decided to locate a new factory in the Panama City area. Stellar 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 Stellar Inc. has no aversion to being a landlord.

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In which building would you recommend that The Stellar 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		$enter a dollar amount rounded to 0 decimal places
Building B		$enter a dollar amount rounded to 0 decimal places
Building C		$enter a dollar amount rounded to 0 decimal places

Answer 1

Solution :

Building A - PV = 610000

Building B - Rent X (PV of Annuity 27 Period at 10% )

                     PV = $70,500 x 9.237

                     PV = 651,208.5

Building B- Rent X (PV of Annuity 27 Period at 10%)

                      PV= 6570 x 9.237

                      PV= $60287

Cash Purchase Price of -              $656,700

Less: PV of Rental Income -       $60,287

Net Present Value -                      $596413

Building C will be recommended because its Present Value of its net cost is lower.

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