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

Question

A 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). c.The store owner is not sure of the 12% WACC

Explanation / Answer

a. 5 years remaining on lease; rent = $2,000/month; 60 payments left, payment at end of month. New lease terms: $0/month for 9 months; $2,600/month for 51 months. Cost of capital = 12% annual (1% per month). Old Lease New Lease Year Cash Flow PV at 1% PV of cash flow Cash Flow PV at 1% PV of cash flow 1 $2,000.00 0.990 $1,980.20 $0.00 0.990 $0.00 2 $2,000.00 0.980 $1,960.59 $0.00 0.980 $0.00 3 $2,000.00 0.971 $1,941.18 $0.00 0.971 $0.00 4 $2,000.00 0.961 $1,921.96 $0.00 0.961 $0.00 5 $2,000.00 0.951 $1,902.93 $0.00 0.951 $0.00 6 $2,000.00 0.942 $1,884.09 $0.00 0.942 $0.00 7 $2,000.00 0.933 $1,865.44 $0.00 0.933 $0.00 8 $2,000.00 0.923 $1,846.97 $0.00 0.923 $0.00 9 $2,000.00 0.914 $1,828.68 $0.00 0.914 $0.00 10 $2,000.00 0.905 $1,810.57 $2,600.00 0.905 $2,353.75 11 $2,000.00 0.896 $1,792.65 $2,600.00 0.896 $2,330.44 12 $2,000.00 0.887 $1,774.90 $2,600.00 0.887 $2,307.37 13 $2,000.00 0.879 $1,757.33 $2,600.00 0.879 $2,284.52 14 $2,000.00 0.870 $1,739.93 $2,600.00 0.870 $2,261.90 15 $2,000.00 0.861 $1,722.70 $2,600.00 0.861 $2,239.51 16 $2,000.00 0.853 $1,705.64 $2,600.00 0.853 $2,217.34 17 $2,000.00 0.844 $1,688.75 $2,600.00 0.844 $2,195.38 18 $2,000.00 0.836 $1,672.03 $2,600.00 0.836 $2,173.65 19 $2,000.00 0.828 $1,655.48 $2,600.00 0.828 $2,152.12 20 $2,000.00 0.820 $1,639.09 $2,600.00 0.820 $2,130.82 21 $2,000.00 0.811 $1,622.86 $2,600.00 0.811 $2,109.72 22 $2,000.00 0.803 $1,606.79 $2,600.00 0.803 $2,088.83 23 $2,000.00 0.795 $1,590.88 $2,600.00 0.795 $2,068.15 24 $2,000.00 0.788 $1,575.13 $2,600.00 0.788 $2,047.67 25 $2,000.00 0.780 $1,559.54 $2,600.00 0.780 $2,027.40 26 $2,000.00 0.772 $1,544.10 $2,600.00 0.772 $2,007.32 27 $2,000.00 0.764 $1,528.81 $2,600.00 0.764 $1,987.45 28 $2,000.00 0.757 $1,513.67 $2,600.00 0.757 $1,967.77 29 $2,000.00 0.749 $1,498.68 $2,600.00 0.749 $1,948.29 30 $2,000.00 0.742 $1,483.85 $2,600.00 0.742 $1,929.00 31 $2,000.00 0.735 $1,469.15 $2,600.00 0.735 $1,909.90 32 $2,000.00 0.727 $1,454.61 $2,600.00 0.727 $1,890.99 33 $2,000.00 0.720 $1,440.21 $2,600.00 0.720 $1,872.27 34 $2,000.00 0.713 $1,425.95 $2,600.00 0.713 $1,853.73 35 $2,000.00 0.706 $1,411.83 $2,600.00 0.706 $1,835.38 36 $2,000.00 0.699 $1,397.85 $2,600.00 0.699 $1,817.20 37 $2,000.00 0.692 $1,384.01 $2,600.00 0.692 $1,799.21 38 $2,000.00 0.685 $1,370.31 $2,600.00 0.685 $1,781.40 39 $2,000.00 0.678 $1,356.74 $2,600.00 0.678 $1,763.76 40 $2,000.00 0.672 $1,343.31 $2,600.00 0.672 $1,746.30 41 $2,000.00 0.665 $1,330.01 $2,600.00 0.665 $1,729.01 42 $2,000.00 0.658 $1,316.84 $2,600.00 0.658 $1,711.89 43 $2,000.00 0.652 $1,303.80 $2,600.00 0.652 $1,694.94 44 $2,000.00 0.645 $1,290.89 $2,600.00 0.645 $1,678.16 45 $2,000.00 0.639 $1,278.11 $2,600.00 0.639 $1,661.54 46 $2,000.00 0.633 $1,265.46 $2,600.00 0.633 $1,645.09 47 $2,000.00 0.626 $1,252.93 $2,600.00 0.626 $1,628.80 48 $2,000.00 0.620 $1,240.52 $2,600.00 0.620 $1,612.68 49 $2,000.00 0.614 $1,228.24 $2,600.00 0.614 $1,596.71 50 $2,000.00 0.608 $1,216.08 $2,600.00 0.608 $1,580.90 51 $2,000.00 0.602 $1,204.04 $2,600.00 0.602 $1,565.25 52 $2,000.00 0.596 $1,192.12 $2,600.00 0.596 $1,549.75 53 $2,000.00 0.590 $1,180.31 $2,600.00 0.590 $1,534.41 54 $2,000.00 0.584 $1,168.63 $2,600.00 0.584 $1,519.21 55 $2,000.00 0.579 $1,157.06 $2,600.00 0.579 $1,504.17 56 $2,000.00 0.573 $1,145.60 $2,600.00 0.573 $1,489.28 57 $2,000.00 0.567 $1,134.26 $2,600.00 0.567 $1,474.53 58 $2,000.00 0.562 $1,123.03 $2,600.00 0.562 $1,459.94 59 $2,000.00 0.556 $1,111.91 $2,600.00 0.556 $1,445.48 60 $2,000.00 0.550 $1,100.90 $2,600.00 0.550 $1,431.17 $89,910.08 $94,611.45 PV of old lease = $89,910.08 ; Pv of new lease = $94,611.45 Sharon should not accept the new lease because the present value of its cost is $94,611.45 - $89,910.08 = $4,701.37 greater than the old lease. b. FV of first 9 months’ rent under old lease: N = 9; I = 1; PV = 0; PMT = -2000; FV = ? FV = $18,737.05. Year Cash flow Fv at 1% F.V of Cash Flow 1 $2,000.00 1.00 $2,000.00 2 $2,000.00 1.01 $2,020.00 3 $2,000.00 1.02 $2,040.20 4 $2,000.00 1.03 $2,060.60 5 $2,000.00 1.04 $2,081.21 6 $2,000.00 1.05 $2,102.02 7 $2,000.00 1.06 $2,123.04 8 $2,000.00 1.07 $2,144.27 9 $2,000.00 1.08 $2,165.71 $18,737.05 The FV of the first 9 months’ rent is equivalent to the PV of the 51-period annuity whose payments represent the incremental rent during months 10-60. To find this value: N = 51; I = 1; PV = -18737.05; FV = 0; PMT = ? PV = PMT(PVIF1%,51) PMT = $470.80. Thus, the new lease payment that will make her indifferent is $2,000 + $470.80 = $2,470.80. Check: 1% 0 1 9 10 59 60 | | · · · | | · · · | | 0 0 -2,470.80 -2,470.80 -2,470.80 PV cost of new lease: CF0 = 0;CF1-9 = 0;CF10-60= -2470.80; I = 1. NPV = -$89,909.99. Except for rounding; the PV cost of this lease equals the PV cost of the old lease. c. Period Old Lease New Lease Difference Lease 0 0 0 0 1-9 -2,000 0 -2,000 10-60 -2,000 -2,600 600 CF0 = 0; CF1-9 = -2000; CF10-60 = 600; IRR = ? IRR = 1.9113%. This is the periodic rate. To obtain the nominal cost of capital, multiply by 12: 12(0.019113) = 22.94%. Check: Old lease terms: N = 60; I = 1.9113; PMT = -2000; FV = 0; PV = ? PV = -$71,039.17. New lease terms: CF0 = 0; CF1-9 = 0; CF10-60 = -2600; I = 1.9113; NPV = ? PV = -$71,038.98.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.