Question

I have a 5,200 square foot tenant space that I am trying to lease at one of our centers. Three tenants have expressed an interest in leasing the space. Two of the tenants require some upfront money from us to move in, while the third tenant does not. This third tenant, however, will not pay as much in rent as the other two. Details on the projected rents from the tenants and the amounts we are to invest upfront are shown below. Using any one of the 3 primary capital budgeting analysis methods (NPV, IRR and/or MIRR) you feel is best and most appropriate, evaluate the three tenants and tell me which of the three tenants I should pursue. My cost of capital is 9.0%.

Tenant 2 - CheeseBurger King
	Initial upfront cost:	($50,000)
	Year 1 rents:	$85,000
	Year 2 rents:	$85,000
	Year 3 rents:	$85,000
	Year 4 rents:	$85,000
	Year 5 rents:	$85,000
Tenant 3 - Old McDonalds
	Initial upfront cost:	$0
	Year 1 rents:	$70,000
	Year 2 rents:	$70,000
	Year 3 rents:	$75,000
	Year 4 rents:	$80,000
	Year 5 rents:	$80,000

Tenant 1 - Fivebucks Coffee and Tea Cost of Capital: 9.0% Initial upfront cost: ($100,000) Year 1 rents: $90,000 Year 2 rents: $95,000 Year 3 rents: $100,000 Year 4 rents: $105,000 Year 5 rents: $110,000

Answer 1

Since you have a choice to make between tenants 1, 2 and 3, and must choose only one among them (mutually exclusive), the most preferrential method I can choose is NPV or Net Present Value because it takes into account the time value of money and each tenant can be evaluated based on its own merits.

Finding NPV tenant 1 , 2 and 3 using the formula,

NPV = PV of cash inflows - PV of cash ouflows

Where PV = FV/(1+r)^n

Where FV = Future value of cashflow

r = cost of capital = 9% = 0.09

n = number of the year in the respective cash flow

Tenant 1: Fivebuck's Coffee and Tea

Given Cost of Capital = 9% = 0.09

Initial upfront cost = PV of cash outflows = 100,000

present value of cash inflows:

PV of CF in year 1 = PV1 = FV1/(1+r)^1 = 90000/(1+0.09)^1 = 90000/1.09 = 82569

PV of CF in year 2 = PV2 = FV2/(1+r)^2 = 95000/(1+0.09)^2 = 95000/1.19 = 79960

PV of CF in year 3 = PV3 = FV3/(1+r)^3 = 100000/(1+0.09)^3 = 100000/1.30 = 77218

PV of CF in year 4 = PV4 = FV4/(1+r)^4 = 105000/(1+0.09)^4 = 105000/1.41 = 74385

PV of CF in year 5 = PV5 = FV5/(1+r)^5 = 110000/(1+0.09)^5 = 110000/1.54 = 71492

PV of cash inflows = PV1+PV2+PV3+PV4+PV5

= 82569+79960+77218+74385+71492

= 385624

Therefore NPV = PV of cash inflows - PV of cash outflows

= 385624-100000

= 285624

NPV of tenant 1 = 285624

Tenant 2: Cheese Burger King

Given Cost of Capital = 9% = 0.09

Initial upfront cost = PV of cash outflows = 50,000

present value of cash inflows:

PV of CF in year 1 = PV1 = FV1/(1+r)^1 = 85000/(1+0.09)^1 = 85000/1.09 = 77982

PV of CF in year 2 = PV2 = FV2/(1+r)^2 = 85000/(1+0.09)^2 = 85000/1.19 = 71543

PV of CF in year 3 = PV3 = FV3/(1+r)^3 = 85000/(1+0.09)^3 = 85000/1.30 = 65636

PV of CF in year 4 = PV4 = FV4/(1+r)^4 = 85000/(1+0.09)^4 = 85000/1.41 = 60216

PV of CF in year 5 = PV5 = FV5/(1+r)^5 = 85000/(1+0.09)^5 = 85000/1.54 = 55244

PV of cash inflows = PV1+PV2+PV3+PV4+PV5

= 77982+71543+65636+60216+55244

= 330620

Therefore NPV = PV of cash inflows - PV of cash outflows

= 330620-50000

= 280620

NPV of tenant 2 = 280620

Tenant 3: Old McDonalds

Given Cost of Capital = 9% = 0.09

Initial upfront cost = PV of cash outflows = 0

present value of cash inflows:

PV of CF in year 1 = PV1 = FV1/(1+r)^1 = 70000/(1+0.09)^1 = 70000/1.09 = 64220

PV of CF in year 2 = PV2 = FV2/(1+r)^2 = 70000/(1+0.09)^2 = 70000/1.19 = 58918

PV of CF in year 3 = PV3 = FV3/(1+r)^3 = 75000/(1+0.09)^3 = 75000/1.30 = 57914

PV of CF in year 4 = PV4 = FV4/(1+r)^4 = 80000/(1+0.09)^4 = 80000/1.41 = 56674

PV of CF in year 5 = PV5 = FV5/(1+r)^5 = 80000/(1+0.09)^5 = 80000/1.54 = 51995

PV of cash inflows = PV1+PV2+PV3+PV4+PV5

= 64220+58918+57914+56674+51995

= 289720

Therefore NPV = PV of cash inflows - PV of cash outflows

= 289720-0

= 289720

NPV of tenant 3 = 289720

when we compare the NPV values of three Tenants,

NPV of tenant 1 = 285624

NPV of tenant 2 = 280620

NPV of tenant 3 = 289720

Accepting one among three tenants is tenant 3 i.e., Old Mc Donalds because the NPV of tenant 3 is greater when when compared with that of tenant 1 and tenant 2.

So you can choose to pursue Tenant 3.