Question

Pronghorn Inc. owns and operates a number of hardware stores in the New England region. Recently, the company has decided to locate another store in a rapidly growing area of Maryland. The company is trying to decide whether to purchase or lease the building and related facilities. Purchase: The company can purchase the site, construct the building, and purchase all store fixtures. The cost would be $1,861,400. An immediate down payment of $406,400 is required, and the remaining $1,455,000 would be paid off over 5 years at $354,200 per year (including interest payments made at end of year). The property is expected to have a useful life of 12 years, and then it will be sold for $508,400. As the owner of the property, the company will have the following out-of-pocket expenses each period. Property taxes (to be paid at the end of each year) $41,860 Insurance (to be paid at the beginning of each year) 26,960 Other (primarily maintenance which occurs at the end of each year) 17,170 $85,990 Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Pronghorn Inc. if Pronghorn will lease the completed facility for 12 years. The annual costs for the lease would be $266,320. Pronghorn would have no responsibility related to the facility over the 12 years. The terms of the lease are that Pronghorn would be required to make 12 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $104,900 is required when the store is opened. This deposit will be returned at the end of the 12th year, assuming no unusual damage to the building structure or fixtures.

Compute the present value of lease vs purchase. (Currently, the cost of funds for Pronghorn Inc. is 11%.)

Answer 1

Pronghorn Inc.
Present value of purchase
	Cash flow				Total Cash flows	PVIF@11%	Present Value of purchase
	Cost	Out of pocket expense
Year		Property taxes	Insurance	Other
0	406400		26960		433360	1	433360
1	354200	41860	26960	17170	440190	0.900901	396567.6
2	354200	41860	26960	17170	440190	0.811622	357268.1
3	354200	41860	26960	17170	440190	0.731191	321863.1
4	354200	41860	26960	17170	440190	0.658731	289966.8
5	354200	41860	26960	17170	440190	0.593451	261231.3
6		41860	26960	17170	85990	0.534641	45973.77
7		41860	26960	17170	85990	0.481658	41417.81
8		41860	26960	17170	85990	0.433926	37313.34
9		41860	26960	17170	85990	0.390925	33615.62
10		41860	26960	17170	85990	0.352184	30284.34
11		41860	26960	17170	85990	0.317283	27283.19
12		41860		17170	59030	0.285841	16873.18
12	-508400				-508400	0.285841	-145321
Total Present value of purchase							2147697
Present Value of Lease
	Cash flow		Total Cash flows	PVIF@11%	Present Value of purchase
	Annual Lease payments
Year		Depsoit
0		104900	104900	1	104900
1	266320		266320	0.900901	239927.9
2	266320		266320	0.811622	216151.3
3	266320		266320	0.731191	194730.9
4	266320		266320	0.658731	175433.2
5	266320		266320	0.593451	158048
6	266320		266320	0.534641	142385.5
7	266320		266320	0.481658	128275.3
8	266320		266320	0.433926	115563.3
9	266320		266320	0.390925	104111.1
10	266320		266320	0.352184	93793.77
11	266320		266320	0.317283	84498.89
12	266320		266320	0.285841	76125.13
12		-104900	-104900	0.285841	-29984.7
Total Present Value of Lease					1803960
Since Present value of lease ($1803960) is lesser compared to present value of purchase($2147697),
we should prefer the leasing option.