A store has 5 years remaining on its lease in a mall. Rent is $2,000 per month,

Question

A store has 5 years remaining on its lease in a mall. Rent is $2,000 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 $2,750 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.) No 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

Present value of existing lease can be calculated using PV

N = 60, I/Y = 1%, PMT = 2,000, FV = 0 => Compute PV = $89,910

With new lease, present value after 9 months

N = 51, I/y = 1%, PMT = 2,750, FV = 0 => Compute PV = $109,445

Its value today = FV / (1 + r)^n = 109,445 / (1 + 1%)^9 = $100,070

Hence, the new lease should not be accepted as it would be more costly for you.

Using trial and error method, we need to find the lease amount such that the present value of both lease are equal

New Lease = $2,470.8 the store owner should be indifferent.

Similarly, using trial and error method,

we get for WACC = 33.80% we get the present value of both leases to be equal.

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