Pronghorn Inc. owns and operates a number of hardware stores in the New England

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%.)

Explanation / Answer

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.

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.