Question

The Bonita 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, Bonita has decided to locate a new factory in the Panama City area. Bonita 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 $611,000, useful life 25 years.
Building B: Lease for 25 years with annual lease payments of $71,370 being made at the beginning of the year.
Building C: Purchase for $657,400 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $6,800. Rental payments will be received at the end of each year. The Nash Inc. has no aversion to being a landlord.

Required:
In which building would you recommend that The Bonita Inc. locate, assuming a cost of funds?

Answer 1

Building C

Step-by-step explanation:

Building A: Purchase for a cash price of $611,000, useful life 25 years.

Building B: Lease for 25 years with annual lease payments of $71,370 being made at the beginning of the year.

Building C: Purchase for $657,400 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $6,800. Rental payments will be received at the end of each year.

11% cost of funds

we must determine the present value of each option:

Building A's present value = $611,000

Building B's present value = $71,370 x 8.4217 (PV annuity due factor, 11%, 25 periods) = $601,057

Building C's present value = $657,400 - ($6,800 x 8.4217) = $657,400 - $57,268 = $600,132 (LOWEST PV)