Question

A company is planning to move to a larger office and is trying to decide if the new office should be owned or leased. Cash flows for owning versus leasing are estimated as follows. Assume that the cash flows from operations will remain level over a 10 year holding period. If purchased, the company will invest $385,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due in year 10. The after-tax cash flow from sale of the property at the end of year 10 is expected to be $750,000. What is the incremental rate of return on equity to the company, if the property is owned instead of leased

Answer 1

Answer: 13.26%

Step-by-step explanation:

Year 0 Investment = $385,000

Incremental Cash flow every year = Cashflow if owned - Cashflow if leased

= 164,000 - 133,000

= $31,500

Incremental cashflow in Year 10 = Incremental Cashflow + Cashflow from sale of property

= 31,500 + 750,000

= $781,500

Using Excel and the IRR function, the rate is = 13.26%