Santa Fe company, which is organized as a 501(c)(3) corporation, which is not fo
ID: 2796846 • Letter: S
Question
Santa Fe company, which is organized as a 501(c)(3) corporation, which is not for profit, is going to acquire a new complex for its headquarters, which will also house some operating functions of the company. The complex is composed of two buildings, which are referred to as Phase I and Phase II with 240,000 and 260,000 sq. ft., respectively. The company is analyzing whether to purchase the complex or to lease the complex.
To purchase the complex, the company will have to pay $212.19 per sp. ft. for Phase I and $245.65 per sq. ft. for Phase II. As the buildings are just completed shells, the company would have to invest additional funds to render the buildings usable. These investments would cost $122.23 per sq. ft. in Phase I and $129.63 per sq. ft. in Phase II. Like the building these investments would be depreciated over 39 years on a straight line basis. According to a professional appraisal, the value of the land in the transaction is valued at 25% of total purchase price for both phases.
The company has historically modeled residual value of properties by increasing the value of land by 3% annually and decreasing the value of the buildings by 2% annually, but there are concerns that calculating residual by that methodology may not be appropriate because this building complex is in Silicon Valley and property values have been rising at a very healthy pace over the past 25 years and are expected to continue to rise.
Alternatively, the company could enter into a 15 year triple net lease[1] for the complex with a monthly lease rate of $1.2833 per sq. ft. per month for Phase I and $1.4883 per sq. ft. per month for Phase II. As the building is just a shell, it would need to make the same investments in the building required in the purchase option. But because this is a lease, these investments would be classified as leasehold improvements[2] and be amortized over the life of the lease. The rent for Phase I escalates at 2% annually for the first 10 years and then at 3% annually for years 11 through 15 and the rent for Phase II escalates at 3% annually for the first 7 years and then at 2.5% annually for years 8 through 15.
For lease versus buy analyses, the company typically uses a discount rate between 6%.
Required:
Calculate the NPV of the lease option at 6%.
Calculate the NPV of the purchase option at 6% using the three methodologies listed to calculate the residual value, so you will have three different NPVs. The base case is the residual value calculated at 3% annual appreciation for land and 2% annual depreciation for the buildings.
Calculate the break-even between the NPV purchase and NPV lease for the base case using the residual value as the independent variable. Stated another way, what does the residual value have to be in order for the lease amount and purchase amount to be equal discounted at 6%.
Please submit your answers on spreadsheet and clearly indicate what your answer is for each question.
[1] Triple net lease is a lease where the lease cost is net of taxes, maintenance and insurance. It does not mean that the lessee will not be responsible for these costs, but is the basis of the lease costs.
[2] Leasehold improvements are improvements to a building that are permanently attached to the building and cannot be removed at the end of the lease and thus have no value at the end of lease term.
Explanation / Answer
Since this is cash out lay, the lower the NPV, better it is for the company. Also given that it is an tax exempt company there would be no tax benefit on amortisation. Plus given that the lease is triple net, the other expenses will be same for both purchase and lease. The calculations are as below:
7,79,65,125.11
The NPV for lease and base case to be equal, the residual value should be $ 48,765,643.70 at the end of 15 years which would require the total property value to depreciate at the rate of 8.26% per annum.
NPV of Lease Option Phase I Phase II Size 2,40,000.00 2,60,000.00 Rent psf monthly 1.2833 1.4883 Monthly Rent 3,07,992.00 3,86,958.00 Annual Rent 36,95,904.00 46,43,496.00 Leasehold Improv. Cost psf 122.23 129.63 Leasehold Improv. Cost 2,93,35,200.00 3,37,03,800.00 Lease Escalation Year 1 to 10 2% Year 11 to 15 3% Year 1 to 7 3% Year 8 t0 15 2.50% Annual Amortisation of Lease Improv. Cost 19,55,680.00 22,46,920.00 Tax Rate 0% Year 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 11.00 12.00 13.00 14.00 15.00 Cash outlay Phase I Lease Rent 36,95,904.00 37,69,822.08 38,45,218.52 39,22,122.89 40,00,565.35 40,80,576.66 41,62,188.19 42,45,431.95 43,30,340.59 44,16,947.40 45,49,455.83 46,85,939.50 48,26,517.69 49,71,313.22 51,20,452.61 Phase II Lease Rent 46,43,496.00 47,82,800.88 49,26,284.91 50,74,073.45 52,26,295.66 53,83,084.53 55,44,577.06 56,83,191.49 58,25,271.28 59,70,903.06 61,20,175.63 62,73,180.03 64,30,009.53 65,90,759.76 67,55,528.76 Total Lease Outflow 83,39,400.00 85,52,622.96 87,71,503.43 89,96,196.35 92,26,861.01 94,63,661.18 97,06,765.25 99,28,623.44 1,01,55,611.87 1,03,87,850.46 1,06,69,631.46 1,09,59,119.53 1,12,56,527.21 1,15,62,072.98 1,18,75,981.37 Disounting @ 6% 78,67,358.49 76,11,803.99 73,64,723.42 71,25,830.12 68,94,847.30 66,71,507.70 64,55,553.28 62,29,341.18 60,11,091.06 58,00,521.44 56,20,628.75 54,46,346.66 52,77,499.21 51,13,916.03 49,55,432.09 Annual Amortisation 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 42,02,600.00 Tax Benefit onAmortisation - - - - - - - - - - - - - - - NPV of lease option = discounted lease cash flows plus upfront lease improvement cost minus tax benefit on amortisation 15,74,85,400.72Related Questions
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