P6-10 (Analysis of Lease vs. Purchase) Dunn Inc. owns and operates a number of h
ID: 2514882 • Letter: P
Question
P6-10 (Analysis of Lease vs. Purchase) Dunn Inc. owns and operates a number of hardware stores in the New England region. Recently, the company has decided to locate another store in a rapidly growing area of Maryland. The company is trying to decide whether to purchase or lease the building and related facilities.Purchase: The company can purchase the site, construct the building, and purchase all store fi xtures.The cost would be $1,850,000. An immediate down payment of $400,000 is required, and the remaining $1,450,000 would be paid off over 5 years at $350,000 per year (including interest payments made at end of year). The property is expected to have a useful life of 12 years, and then it will be sold for $500,000. As the owner of the property, the company will have the following out-of-pocket expenses each period.Property taxes (to be paid at the end of each year) $40,000Insurance (to be paid at the beginning of each year) 27,000Other (primarily maintenance which occurs at the end of each year) 16,000 $83,000Lease: First National Bank has agreed to purchase the site, construct the building, and install the ap-propriate fi xtures for Dunn Inc. if Dunn will lease the completed facility for 12 years. The annual costs forthe lease would be $270,000. Dunn would have no responsibility related to the facility over the 12 years. The terms of the lease are that Dunn would be required to make 12 annual payments (the fi rst paymentto be made at the time the store opens and then each following year). In addition, a deposit of $100,000 is required when the store is opened. This deposit will be returned at the end of the twelfth year, assuming no unusual damage to the building structure or fi xturesInstructionsWhich of the two approaches should Dunn Inc. follow? (Currently, the cost of funds for Dunn Inc. is 10%.)
Explanation / Answer
Purchase a b c d e=a+b+c+d f g=e*f Year Down Payment, Installment & Sale Property tax year end Insurance at year beginning Other maintainence year end Total cash outflow Present value factor@10% Present value of cashoutflow 0 400,000 27000 427,000 1 1 427,000 1 350,000 40000 27000 16000 433,000 0.90909091 =(1/1.1)^1 393,636 2 350,000 40000 27000 16000 433,000 0.82644628 =(1/1.1)^2 357,851 3 350,000 40000 27000 16000 433,000 0.7513148 =(1/1.1)^3 325,319 4 350,000 40000 27000 16000 433,000 0.68301346 =(1/1.1)^4 295,745 5 350,000 40000 27000 16000 433,000 0.62092132 =(1/1.1)^5 268,859 6 40000 27000 16000 83,000 0.56447393 =(1/1.1)^6 46,851 7 40000 27000 16000 83,000 0.51315812 =(1/1.1)^7 42,592 8 40000 27000 16000 83,000 0.46650738 =(1/1.1)^8 38,720 9 40000 27000 16000 83,000 0.42409762 =(1/1.1)^9 35,200 10 40000 27000 16000 83,000 0.38554329 =(1/1.1)^10 32,000 11 40000 27000 16000 83,000 0.3504939 =(1/1.1)^11 29,091 12 -500000 40000 16000 (444,000) 0.31863082 =(1/1.1)^12 (141,472) Present cost of purchasing 2,151,393 Leasing a b c=a+b d e=c*d Year Annual lease at year beginning Deposit Total cash outflow Present value factor@10% Present value of cashoutflow 0 270,000 100000 370,000 1 1 370,000 1 270,000 270,000 0.90909091 =(1/1.1)^1 245,455 2 270,000 270,000 0.82644628 =(1/1.1)^2 223,140 3 270,000 270,000 0.7513148 =(1/1.1)^3 202,855 4 270,000 270,000 0.68301346 =(1/1.1)^4 184,414 5 270,000 270,000 0.62092132 =(1/1.1)^5 167,649 6 270,000 270,000 0.56447393 =(1/1.1)^6 152,408 7 270,000 270,000 0.51315812 =(1/1.1)^7 138,553 8 270,000 270,000 0.46650738 =(1/1.1)^8 125,957 9 270,000 270,000 0.42409762 =(1/1.1)^9 114,506 10 270,000 270,000 0.38554329 =(1/1.1)^10 104,097 11 270,000 270,000 0.3504939 =(1/1.1)^11 94,633 12 -100000 (100,000) 0.31863082 =(1/1.1)^12 (31,863) Present cost of leasing 2,091,803 Since the cost of leasing is less than cost of purchasing. Lease should be opted.
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