Your boss has decided to assign you the task of analyzing two financing alternat

Question

Your boss has decided to assign you the task of analyzing two financing alternatives for a self-storage facility that is a potential investment for the company’s portfolio. Although your company usually develops and operates its own self-storage facilities, a competitor has decided to exit the industry and is selling their portfolio. Here is information on the self-storage facility. The net operating income (NOI) is expected to be $200,000 per year the first year and will increase at a 3.5 percent rate per year. You can purchase the investment for $1,500,000. This price includes the value of the land and the building. An appraiser estimates that 80.0 percent of the purchase price be allocated to building and 20.0 percent to land. The building is in the 39-year depreciation class and will be depreciated straight-line to a zero salvage value. The property under consideration is expected to increase at a 4.0 percent annual rate over the four-year holding period. Because of recent tax law changes, your company is in the 21 percent tax bracket. The lender has offered the following financing alternatives:

1. A 10.0 percent conventional, fixed rate, constant payment loan for $1,125,000 (75.0 percent of purchase price) with a 10-year term.

2. A sale-leaseback of the land to a third-party that specializes in land leases. The land is still valued at 20.0 percent of the purchase price and a conventional loan with the exact same terms as above. This means that the loan amount is now $900,000 = ($1,500,000 - $1,500,000*0.2)*0.75, instead of $1,125,000. The annual lease payments over the next four years will be $22,000.

Explanation / Answer

Soln : Please refer the calculation of cash flows, using the Alternative 1:

Net Income = 288064

Now calculation for alternative 2:

Net Income over 4 years = 282945

We can see here that alternative 1 is better option as Net income in 4 years is higher for alternative 1

Year 0 1 2 3 4 NOI 200000 207000 214245 221743.575 Depreciation 30769.23 30769.23 30769.23 30769.23 Interest expense 112500.00 105441.14 97676.40 89135.18 Net Income 56730.77 70789.63 85799.37 101839.16 Appreciation in land 12000.00 12480.00 12499.20 12499.97 Income after taxes 54297.31 65783.01 77655.87 90327.91

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