Question

The Sunland 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, Sunland has decided to locate a new factory in the Panama City area. Sunland 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 $612,100, useful life 26 years. Building B: Lease for 26 years with annual lease payments of $71,490 being made at the beginning of the year. Building C: Purchase for $655,200 cash. This building is larger than needed; however, the excess space can be sublet for 26 years at a net annual rental of $6,850. Rental payments will be received at the end of each year. The Sunland Inc. has no aversion to being a landlord.

Instructions:
In which building would you recommend that Brubaker Inc. locate, assuming a 12% cost of funds?

Answer 1

Building C

Step-by-step explanation:

To solve this, we find the present value of each of the buildings.

Building A: We are told that it is to be Purchased for a cash price of $612,100, useful life 26 years. Thus;

PV = $612000

Building B: PV = 71490 + (71490 × ((1+r)ⁿ - 1)/(r(1+r)ⁿ)

Where,

r = 12% = 0.12

n = 26 - 1 = 25

Thus;

PV = 71490 + (71490 × (1 + 0.12)^(25) -1)/(0.12(1 + 0.12)^25)

PV = = $632196

Building C:

PV = 655200 - 6850 × ((1+r)ⁿ - 1)/(r(1+r)ⁿ)

Where;

r = 12% = 0.12

n=26

Thus;

PV = 655200 - (6850 × (1 + 0.12)^(25) -1)/(0.12(1 + 0.12)^25)

PV = $601474

Thus, the minimum PV is building C and therefore it is the one I will recommend that Brubaker Inc. locate