Genesco is considering two alternative 5-year leases. The first lease is for $2,

Question

Genesco is considering two alternative 5-year leases. The first lease is for $2,400 per month for 60 months. The second lease has no rent for the first 9 months, and then even monthly payments for the remaining 51 months. The company uses a WACC of 12% (monthly discounting of 1% per month) to evaluate these types of situations. At what lease payment amount on the second lease would the company be indifferent between these two options? Your answer should be between 2000.00 and 3000.00, rounded to 2 decimal places, with no special characters.

Explanation / Answer

Step 1: Calculate Present Value of Lease Payments under Lease 1

The present value of lease payments under lease 1 can be calculated with the use of PV (Present Value) function/formula of EXCEL/Financial Calculator. The function/formula for PV is PV(Rate,Nper,PMT,FV) where Rate = Interest Rate, Nper = Period, PMT = Payment and FV = Future Value (if any).

Here, Rate = 1%, Nper = 60, PMT = $2,400 and FV = 0

Using these values in the above function/formula for PV, we get,

Present Value of Lease Payments (Lease 1) = PV(1%,60,2400,0) = $107,892.09

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Step 2: Calculate Future Value of Total Present Value (Lease 1) after 9 Months

The future value can be calculated with the use of FV (Future Value) function/formula of EXCEL/Financial Calculator. The function/formula for FV is FV(Rate,Nper,PMT,PV) where Rate = Interest Rate, Nper = Period, PMT = Payment and PV = Present Value.

Here, Rate = 1%, Nper = 9, PMT = 0 and PV = $107,892.09

Using these values in the above function/formula for FV, we get,

Future Value after 9 Months (Lease 1) = FV(1%,9,0,107892.09) = $118,000

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Step 3: Calculate Monthly Payment under Lease 2

The monthly lease payment under lease 2 can be calculated with the use of PMT (Payment) function/formula of EXCEL/Financial Calculator. The function/formula for PMT is PMT(Rate,Nper,PV,FV) where Rate = Interest Rate, Nper = Period, PV = Present Value and FV = Future Value.

Here, Rate = 1%, Nper = 51, PV = 118,000 and FV = 0

Using these values in the above function/formula for PMT, we get,

Monthly Payment under Lease 2 = PMT(1%,51,118000,0) = $2,964.96 (answer)

At a monthly lease payment of $2,964.96 on the second lease, the company would be indifferent between the two options.

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