Problem 6-9 (Part Level Submission) James Kirk is a financial executive with McD

Question

Problem 6-9 (Part Level Submission)

James Kirk is a financial executive with McDowell Enterprises. Although James Kirk has not had any formal training in finance or accounting, he has a “good sense” for numbers and has helped the company grow from a very small company ($542,500 sales) to a large operation ($48,825,000 in sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which James Kirk feels a little “over his head.” He therefore has decided to hire a new employee with “numbers” expertise to help him. As a basis for determining whom to employ, he has decided to ask each prospective employee to prepare answers to questions relating to the following situations he has encountered recently. Here are the questions. (Use the tables below.)

In 2013, McDowell Enterprises negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On January 1, 2014, McDowell took possession of the leased property. The 20-year lease is effective for the period January 1, 2014, through December 31, 2033. Advance rental payments of $823,200 are payable to the lessor (owner of facilities) on January 1 of each of the first 10 years of the lease term. Advance payments of $413,400 are due on January 1 for each of the last 10 years of the lease term. McDowell has an option to purchase all the leased facilities for $1 on December 31, 2033. At the time the lease was negotiated, the fair value of the truck terminals and freight storage facilities was approximately $7,206,800. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest.

Compute the present value of lease vs purchase. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

PRESENT VALUE FOR LEASE???

PRESENT VALUE FOR PURCHASE???

(PLEASE EXPLAIN USING P.V. TABLE)

``````THANK YOU

Explanation / Answer

Advance pv factor Present Year Rental at 10% Value 0 823200 1 823200 1 823200 0.909091 748363.6 2 823200 0.826446 680330.6 3 823200 0.751315 618482.3 4 823200 0.683013 562256.7 5 823200 0.620921 511142.4 6 823200 0.564474 464674.9 7 823200 0.513158 422431.8 8 823200 0.466507 384028.9 9 823200 0.424098 349117.2 10 413400 0.385543 159383.6 11 413400 0.350494 144894.2 12 413400 0.318631 131722 13 413400 0.289664 119747.3 14 413400 0.263331 108861.1 15 413400 0.239392 98964.67 16 413400 0.217629 89967.88 17 413400 0.197845 81788.99 18 413400 0.179859 74353.62 19 413400 0.163508 67594.2 Total 6641306 Present Value for the Lease = 6,641,306 Present Value for the Purchase = 7,206,800 * 1 = 7,206,800 Hence Lease is better than Purchase.

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