Wyndham Stores operates a regional chain of upscale department stores. The compa
ID: 2643095 • Letter: W
Question
Wyndham Stores operates a regional chain of upscale department stores. The company is going to open another store soon in a prosperous and growing suburban area. In discussing how the company can acquire the desired building and other facilities needed to open the new store, Harry Wilson, the company
Wyndham Stores operates a regional chain of upscale department stores. The company is going to open another store soon in a prosperous and growing suburban area. In discussing how the company can acquire the desired building and other facilities needed to open the new store, Harry Wilson, the company
Wyndham Stores operates a regional chain of upscale department stores. The company is going to open another store soon in a prosperous and growing suburban area. In discussing how the company can acquire the desired building and other facilities needed to open the new store, Harry Wilson, the company's marketing vice president, 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 $12 million. They also say that property taxes, insurance, maintenance, and repairs would run $200,000 a year. When you figure that we plan to keep a site for 15 years, that?s a total cost of $15 million. But then when you realize that the building and property will be worth at least $5 million in 15 years, that?s a net cost to us of only $10 million. Leasing costs a lot more than that. I?m not so sure, replied Erin Reilley, the company?s executive vice president. Guardian 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 15 years for an annual lease payment of only $1 million. That?s just my point, said Harry. At $1 million a year, it would cost us $15 million over the 15 years instead of just $10 million. And what would we have left at the end? Nothing! The building would belong to the insurance company! I?ll bet they would even want the first lease payment in advance. That?s right, replied Erin. We would have to make the first payment immediately and then one payment at the beginning of each of the following 14 years. However, you?re overlooking a few things. For one thing, we would have to tie up a lot of our funds for 15 years under the purchase alternative. We would have to put $6 million down immediately if we buy the property, and then we would have to pay the other $6 million off over three years at $2 million a year. But that cost is nothing compared to $15 million for leasing, said Harry. Also, if we lease, I understand we would have to put up a $580,000 security deposit that we wouldn?t get back until the end. And besides that, we would still have to pay all the repair 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 Erin. But I do have the operating cost breakdown for the building, which includes $89,000 annually for property taxes, $70,000 for insurance, and $41,000 for repairs and maintenance. If we lease, Guardian will handle its own insurance costs and will pay the property taxes, but we?ll have to pay for the repairs and maintenance. I need to put all this together and see if leasing makes any sense with our 10% before-tax required rate of return. The president wants a presentation and recommendation in the executive committee meeting tomorrow, (Ignore income taxes.) Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. Calculate the net present value if the investment of the property is leased. (Negative amount should be indicated by a minus sign. Round discount factor(s) to 3 decimal places, other intermediate calculations and final answer to the nearest whole dollar.) Net present value $Explanation / Answer
Answer:
years Cash flow 12% factor Present value of cash flows Purchase of facility Initial payment now -6000000 1 -6000000 Annual payments 1 to 4 -2000000 3.037 -6074000 Annual cash operating costs 1 to 20 -200000 7.469 -1493800 Resale value 20 5000000 0.104 520000 Present value of cash flows -13047800 Lease of facility Initial deposit now -400000 1 -400000 First lease payment now -1000000 1 -1000000 Remaining lease payment 1 to 19 -1000000 7.366 -7366000 Annual repair and maintenace 1 to 20 -50000 6.469 -373450 Return of deposit 20 400000 0.104 41600 Present value of cash flow -9097850 Net present value in favor of leasing 3949950Related Questions
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