E6-12 (LO4) (Analysis of Alternatives) The Black Knights Inc., a manufacturer of
ID: 2437470 • Letter: E
Question
E6-12 (LO4) (Analysis of Alternatives) The Black Knights 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, Black Knights has decided to locate a new factory in the Panama City area. Black Knights 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 $600,ooo, useful life 25 years. Building B: Lease for 25 years with annual lease payments of $69,000 being made at the beginning of the year. Building C: Purchase for $650,o00 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $7,000. Rental payments will be received at the end of each year. The Black Knights Inc. has no aversion to being a landlord. Instructions in which building would you recommend that The Black Knights Inc. locate, assuming a 12% cost of funds?Explanation / Answer
Solution: Building C
Working
Option: Building A
PV= $600,000
Option: Building B
PV = $69,000 X 8.78432
PV = $606,118.08
Option: Building C
PV = $7,000 X 7.84314
PV = $54,901.98
Cash purchase price
$650,000.00
Minus: Present value of rental income
54,901.98
NPV
$595,098.02
Considering the above options, I would recommend The Black Knights Inc. to lease Building C because the present value of its net cost is the smallest
Cash purchase price
$650,000.00
Minus: Present value of rental income
54,901.98
NPV
$595,098.02
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