Question

(NPV and IRR)

A store has 5 years remaining on its lease in a mall. Rent is $2,100 per month, 60 payments remain, and the next payment is due in 1 month. The mall's owner plans to sell the property in a year and wants rent at that time to be high so that the property will appear more valuable. Therefore, the store has been offered a "great deal" (owner's words) on a new 5-year lease. The new lease calls for no rent for 9 months, then payments of $2,500 per month for the next 51 months. The lease cannot be broken, and the store's WACC is 12% (or 1% per month).

1. Should the new lease be accepted? (Hint: Be sure to use 1% per month.)
   (choose from yes or no)

___________

1. 
   
2. If the store owner decided to bargain with the mall's owner over the new lease payment, what new lease payment would make the store owner indifferent between the new and old leases? (Hint: Find FV of the old lease's original cost at t = 9; then treat this as the PV of a 51-period annuity whose payments represent the rent during months 10 to 60.) Do not round intermediate calculations. Round your answer to the nearest cent.
   ___________$  
3. 
   
4. The store owner is not sure of the 12% WACC—it could be higher or lower. At what nominal WACC would the store owner be indifferent between the two leases? (Hint: Calculate the differences between the two payment streams; then find its IRR.) Do not round intermediate calculations. Round your answer to two decimal places.
   ___________ %

Answer 1

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Answer:

1) PV of the lease payments under the existing arrangement:
= 2100*(1.01^60-1)/(0.01*1.01^60) =		94405.58
PV of the lease payments under the 'great deal':
= ((2500*(1.01^51-1)/(0.01*1.01^51))/1.01^9 =		90972.55
As the PV of the payments under the 'great deal' is lower than the PV of the
payments under the exisitng arrangement, the store owner can accept the 'great deal'.
2) As the 'great deal' is beneficial to the store owner, there is no need for bargaining.
New lease payment which will make the store owner indiferent
= 94405.58*1.01^9*(0.01*1.01^51)/(1.01^51-1) =			2594.34
3) Cash flow difference between the two streams:
months 1 to 9 = $2100
months 10 to 60 = -$400
IRR/12 is the value of r in the following equation:
2100*pvifa(r,9)-400*pvifa(r,51)*pvif(r,9) = 0
The value of r is to be found out by trial and error:
Taking r as 1.25
=2100*(1.0125^9-1)/(0.0125*1.0125^9)-((400*(1.0125^51-1)/(0.0125*1.0125^51))/1.0125^9 =						4342.0257
Taking r as 1.5%
=2100*(1.015^9-1)/(0.015*1.015^9)-((400*(1.015^51-1)/(0.015*1.015^51))/1.015^9)						5149.1857
Taking r as 0.25%
=2100*(1.0025^9-1)/(0.0025*1.0025^9)-((400*(1.0025^51-1)/(0.0025*1.0025^51))/1.0025^9)						-39.63416
Correct value of r = 0.25+39.63/(4342.0257+39.63416) =			0.2590445
Annual rate = r*12 =			3.1085342	= 3.11%
To be indifferent WACC should be 3.11%