Exercise 6-12 The Culver Inc., a manufacturer of low-sugar, low-sodium, low-chol
ID: 2341425 • Letter: E
Question
Exercise 6-12
The Culver 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, Culver has decided to locate a new factory in the Panama City area. Culver 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 $619,800, useful life 26 years.
Building B: Lease for 26 years with annual lease payments of $71,730 being made at the beginning of the year.
Building C: Purchase for $650,100 cash. This building is larger than needed; however, the excess space can be sublet for 26 years at a net annual rental of $6,810. Rental payments will be received at the end of each year. The Culver Inc. has no aversion to being a landlord.
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In which building would you recommend that The Culver Inc. locate, assuming a 11% 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.)
Explanation / Answer
Solution:
Net present value of Building A = The cash price paid today = $ 650,100
Net present value of Building B = $71,730* sum of PV factor of 26 years @ 11%
= $71,730 * 8.48806 = $608,849
Net present value of Building C= $650,100 - PV of net annual rentals
= $650,100 - $6,810 * 8.48806 = $592,296
Since, the present value of Building C. is lower then the others. Thus the Culver Inc, should locate itself in Building C.
Note: All the amounts of NPV calculated above are negative because company would pay to acquire building and it's the outflow of cash. I did not put negative sign.
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