store has 5 years remaining on its lease in a mall. Rent is $1,900 per month, 60

Question

store has 5 years remaining on its lease in a mall. Rent is $1,900 per month, 60 payments remain, and the next payment is due in 1 month. The mall's owner plans to sell the property in a year and wants rent at that time to be high so that the property will appear more valuable. Therefore, the store has been offered a "great deal" (owner's words) on a new 5-year lease. The new lease calls for no rent for 9 months, then payments of $2,600 per month for the next 51 months. The lease cannot be broken, and the store's WACC is 12% (or 1% per month).

a-Should the new lease be accepted? (Hint: Be sure to use 1% per month.)

b- If the store owner decided to bargain with the mall's owner over the new lease payment, what new lease payment would make the store owner indifferent between the new and old leases? (Hint: Find FV of the old lease's original cost at t = 9; then treat this as the PV of a 51-period annuity whose payments represent the rent during months 10 to 60.) Round your answer to the nearest cent. Do not round your intermediate calculations.

c- The store owner is not sure of the 12% WACC—it could be higher or lower. At what nominal WACC would the store owner be indifferent between the two leases? (Hint: Calculate the differences between the two payment streams; then find its IRR.) Round your answer to two decimal places. Do not round your intermediate calculations.

Explanation / Answer

Part - a

Answer : New Lease should be accepted as NPV under new Scheme is higher than NPV under Old Scheme.

Part b

Monthly rent should be $ 2347.26

Part C

Under old Lease Scheme Monthly Cash Inflow $1900 Period of Lease 60 Months WACC 1% per Month PV Factor for 1%p.m for 60 Months                                                                                              44.955 Present Value of Lease    =    Monthly Rent * PV factor @1% for 60 Months = 1900 * 44.955 = 85,414.50 Under New Lease Scheme Monthly Cash Inflow For 1 to 9 Months NIL Monthly Cash Inflow for 10 to 60 Months $2600 Period of Lease 51 Months WACC 1% per Month PV Factor for 1%p.m for 10 to 60 Months                                                                                              36.389 Present Value of Lease    =    Monthly Rent * PV factor @1% for 10 to 60 Months = 2600 * 44.955 = 94,611.45

Answer : New Lease should be accepted as NPV under new Scheme is higher than NPV under Old Scheme.

Part b

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