In 2013, McDowell Enterprises negotiated and closed a long-term lease contract f

Question

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 $816,200 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 $408,600 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 $7,220,800. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest.

a) Compute the present value of lease vs purchase.

b) McDowell Enterprises should Lease or purchase the facilties?

Explanation / Answer

Present Value of first ten payments

= $816,200 (PVIFA10%,10) = =816200*(6.75902) =5516712

Present Value of Last ten payments

= $816200*(8.36492-5.759)

= $816200*(2.6059) = 1064769

Total Cost of leasing Facility =5516712+1064769 = 6581481

Since present Value of lease payment is less than Cost of purchase we may Lease the equipment.

We can Do this problem in another way

Year Cash flow PV favtor 10% Present Value 0 816200 1.00000 816200 1 816200 0.90909 742000 2 816200 0.82645 674545 3 816200 0.75131 613223 4 816200 0.68301 557476 5 816200 0.62092 506796 6 816200 0.56447 460724 7 816200 0.51316 418840 8 816200 0.46651 380763 9 816200 0.42410 346148 10 408600 0.38554 157533 11 408600 0.35049 143212 12 408600 0.31863 130193 13 408600 0.28966 118357 14 408600 0.26333 107597 15 408600 0.23939 97816 16 408600 0.21763 88923 17 408600 0.19784 80839 18 408600 0.17986 73490 19 408600 0.16351 66809 Present Value 6581484.45

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