I am so lost. I have tried multiple methods and and have gotten them all wrong.
ID: 2370003 • Letter: I
Question
I am so lost. I have tried multiple methods and and have gotten them all wrong. Please help me!! I don't understand the NPV in excel, I always get it wrong. I need to be shown every step so that I understand it.Top-Quality Stores, Inc., owns a nationwide chain of supermarkets. The company is going to open another store soon, and a suitable building site has been located in an attractive and rapidly growing area. In discussing how the company can acquire the desired building and other facilities needed to open the new store, Sam Watkins, the company's vice president in charge of sales, stated, "I know most of our competitors are starting to lease facilities rather than buy, but I just can't see the economics of it. Our development people tell me that we can buy the building site, put a building on it, and get all the store fixtures we need for just $853,000. They also say that property taxes, insurance, and repairs would run $21,400 a year. When you figure that we plan to keep a site for 18 years, that's a total cost of $944,100. But then when you realize that the property will be worth at least a half million in 18 years, that's a net cost to us of only $444,100. What would it cost to lease the property?"
"I understand that Beneficial Insurance Company is willing to purchase the building site, construct a building and install fixtures to our specifications, and then lease the facility to us for 18 years at an annual lease payment of $122,000," replied Lisa Coleman, the company's executive vice president.
"That's just my point," said Sam. "At $122,000 a year, it would cost us a cool $2,196,000 over the 18 years. That's three times what it would cost to buy, and what would we have left at the end? Nothing! The building would belong to the insurance company!"
"You're overlooking a few things," replied Lisa. "For one thing, the treasurer's office says that we could only afford to put $352,000 down if we buy the property, and then we would have to pay the other $501,000 off over 4 years at $157,000 a year. So there would be some interest involved on the purchase side that you haven't figured in."
"But that little bit of interest is nothing compared to over 2 million bucks for leasing," said Sam. "Also, if we lease I understand we would have to put up an $7,800 security deposit that we wouldn't get back until the end. And besides that, we would still have to pay all the yearly repairs and maintenance costs just like we owned the property. No wonder those insurance companies are so rich if they can swing deals like this."
"Well, I'll admit that I don't have all the figures sorted out yet," replied Lisa. "But I do have the operating cost breakdown for the building, which includes $8,300 annually for property taxes, $9,000 for insurance, and $4,100 for repairs and maintenance. If we lease, Beneficial will handle its own insurance costs and of course the owner will have to pay the property taxes. I'll put all this together and see if leasing makes any sense with our required rate of return of 16%. The president wants a presentation and recommendation in the executive committee meeting tomorrow. Let's see, development said the first lease payment would be due now and the remaining ones due in years 1 I am so lost. I have tried multiple methods and and have gotten them all wrong. Please help me!! I don't understand the NPV in excel, I always get it wrong. I need to be shown every step so that I understand it.
Top-Quality Stores, Inc., owns a nationwide chain of supermarkets. The company is going to open another store soon, and a suitable building site has been located in an attractive and rapidly growing area. In discussing how the company can acquire the desired building and other facilities needed to open the new store, Sam Watkins, the company's vice president in charge of sales, stated, "I know most of our competitors are starting to lease facilities rather than buy, but I just can't see the economics of it. Our development people tell me that we can buy the building site, put a building on it, and get all the store fixtures we need for just $853,000. They also say that property taxes, insurance, and repairs would run $21,400 a year. When you figure that we plan to keep a site for 18 years, that's a total cost of $944,100. But then when you realize that the property will be worth at least a half million in 18 years, that's a net cost to us of only $444,100. What would it cost to lease the property?"
"I understand that Beneficial Insurance Company is willing to purchase the building site, construct a building and install fixtures to our specifications, and then lease the facility to us for 18 years at an annual lease payment of $122,000," replied Lisa Coleman, the company's executive vice president.
"That's just my point," said Sam. "At $122,000 a year, it would cost us a cool $2,196,000 over the 18 years. That's three times what it would cost to buy, and what would we have left at the end? Nothing! The building would belong to the insurance company!"
"You're overlooking a few things," replied Lisa. "For one thing, the treasurer's office says that we could only afford to put $352,000 down if we buy the property, and then we would have to pay the other $501,000 off over 4 years at $157,000 a year. So there would be some interest involved on the purchase side that you haven't figured in."
"But that little bit of interest is nothing compared to over 2 million bucks for leasing," said Sam. "Also, if we lease I understand we would have to put up an $7,800 security deposit that we wouldn't get back until the end. And besides that, we would still have to pay all the yearly repairs and maintenance costs just like we owned the property. No wonder those insurance companies are so rich if they can swing deals like this."
"Well, I'll admit that I don't have all the figures sorted out yet," replied Lisa. "But I do have the operating cost breakdown for the building, which includes $8,300 annually for property taxes, $9,000 for insurance, and $4,100 for repairs and maintenance. If we lease, Beneficial will handle its own insurance costs and of course the owner will have to pay the property taxes. I'll put all this together and see if leasing makes any sense with our required rate of return of 16%. The president wants a presentation and recommendation in the executive committee meeting tomorrow. Let's see, development said the first lease payment would be due now and the remaining ones due in years 1
Explanation / Answer
Net Present Value (NPV) Net present value is the present value of net cash inflows generated by a project including salvage value, if any, less the initial investment on the project. It is one of the most reliable measures used in capital budgeting because it accounts for time value of money by using discounted cash inflows. Before calculating NPV, a target rate of return is set which is used to discount the net cash inflows from a project. Net cash inflow equals total cash inflow during a period less the expenses directly incurred on generating the cash inflow. Calculation Methods and Formulas The first step involved in the calculation of NPV is the determination of the present value of net cash inflows from a project or asset. The net cash flows may be even (i.e. equal cash inflows in different periods) or uneven (i.e. different cash flows in different periods). When they are even, present value can be easily calculated by using the present value formula of annuity. However, if they are uneven, we need to calculate the present value of each individual net cash inflow separately. In the second step we subtract the initial investment on the project from the total present value of inflows to arrive at net present value. Thus we have the following two formulas for the calculation of NPV: When cash inflows are even: NPV = R
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