Swifty Inc. owns and operates a number of hardware stores in the New England reg
ID: 2590685 • Letter: S
Question
Swifty 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 $1,857,100. An immediate down payment of $404,100 is required, and the remaining $1,453,000 would be paid off over 5 years at $356,900 per year (including interest payments made at end of year). The property is expected to have a useful life of 11 years, and then it will be sold for $505,800. As the owner of the property, the company will have the following out-of-pocket expenses each period.
$40,990
27,040
17,590
$85,620
Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Swifty Inc. if Swifty will lease the completed facility for 11 years. The annual costs for the lease would be $292,510. Swifty would have no responsibility related to the facility over the 11 years. The terms of the lease are that Swifty would be required to make 11 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $91,100 is required when the store is opened. This deposit will be returned at the end of the 11th 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 Swifty Inc. is 10%.) (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 Swifty Inc. follow?
$40,990
Insurance (to be paid at the beginning of each year)27,040
Other (primarily maintenance which occurs at the end of each year)17,590
$85,620
Explanation / Answer
Purchase option model
Particulars
amount
Pv factor (10%)
Pv annuity (10%)
Pv *amout
Down payment
404100
0
0
404100
Installment (5 years)
356900
0
3.791
13,53008
Property tax(11 years)
40990
0
6.495
266230
insurance
27040
0
7.145
193201
Other expense
17590
0
6.495
114248
Less : sale of salvage value 11 th year
(505800)
.350
0
(177030)
Total cost on purchase
21,53,757
Lease option model
Particulars
amount
Pv factor (10%)
Pv annuity (10%)
Pv *amout
deposit
91100
0
0
91100
Lease payment beginning of each year
292510
7.145
20,8,984
2181084
Less deposit return
91100
.350
(31885)
Total cost on lease
2149199
better option is purchase than lease.
Purchase option model
Particulars
amount
Pv factor (10%)
Pv annuity (10%)
Pv *amout
Down payment
404100
0
0
404100
Installment (5 years)
356900
0
3.791
13,53008
Property tax(11 years)
40990
0
6.495
266230
insurance
27040
0
7.145
193201
Other expense
17590
0
6.495
114248
Less : sale of salvage value 11 th year
(505800)
.350
0
(177030)
Total cost on purchase
21,53,757
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