Problem 6-10 Waterway Inc. owns and operates a number of hardware stores in the
ID: 2542517 • Letter: P
Question
Problem 6-10
Waterway 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 $1,855,000. An immediate down payment of $414,500 is required, and the remaining $1,440,500 would be paid off over 5 years at $361,600 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 $501,500. As the owner of the property, the company will have the following out-of-pocket expenses each period.
$41,810
26,960
16,340
$85,110
Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Waterway Inc. if Waterway will lease the completed facility for 12 years. The annual costs for the lease would be $252,470. Waterway would have no responsibility related to the facility over the 12 years. The terms of the lease are that Waterway 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 $92,800 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.
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Compute the present value of lease vs purchase. (Currently, the cost of funds for Waterway Inc. is 9%.) (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)
Which of the two approaches should Waterway Inc. follow?
purchase
Property taxes (to be paid at the end of each year)$41,810
Insurance (to be paid at the beginning of each year)26,960
Other (primarily maintenance which occurs at the end of each year)16,340
$85,110
Explanation / Answer
Purchasing : Down Payment $ 4,14,500 Installment $ 14,06,497 Property Taxes/Other $ 4,16,397 Insurance $ 2,10,428 Total Cost $ 24,47,822 Less : Salvage Value $ 1,78,301 Present Value for Purchase $ 22,69,521 Working Notes Installment = $ 361,600 X 3.88965 = $ 14,06,497 ( P.V Annuity factor for 5 Years = 3.88965) Property Taxes/Other = ($ 41,810 + $16340 ) X 7.16073 = $ 4,16,397 ( P.V Annuity factor for 12 Years = 7.16073) Insurance = ($26,960 X 6.8052 ) + $26960 = $ 2,10,428 ( P.V Annuity factor for 11 Years = 6.8052, Here Payment is done in the beginning of every year.) Salvage Value = $501,500 X 0.355535 = $ 1,78,301 ( P.V Interest factor for 12th Year = 0.355535) Lease: Lease Payment $ 19,70,579 Interest Lost $ 66,452 Present Value for Leasing $ 20,37,031 Working Notes Lease Payment = ($ 252,470 X 6.8052 ) + $ 252,470 = $ 19,70,579 ( P.V Annuity factor for 11 Years = 6.8052, Here Payment is done in the beginning of every year.) Interest Lost = $ 92,800 X 7.16073 = $ 66,452 ( P.V Annuity factor for 12 Years = 7.16073) Hence Waterway Inc. Should lease the building and related facilities instead of buying them. The net cost for leasing is $ 2,037,031 compared to net cost of purchase $ 2,269,521. Lease Purchase Present Value $ 2,037,031 $ 2,269,521