8. Problem 11.18 NPV AND IRR A store has 5 years remaining on its lease in a mal

Question

8. Problem 11.18 NPV AND IRR 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 $2,500 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 190 per month.) -Select-+ 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

a) Let's calculate the present value of both options using PV function

For existing lease, N = 60, PMT = 1,900, I/Y = 12%/12 = 1%, FV = 0 => Compute PV = $85,414.57

For new lease, N = 51, PMT = 2,500, I/Y = 1%, FV = 0 => Compute PV = $99,495.34

but this is the value in 9 months, its value today = $99,495.34 / (1 + 1%)^9 = $90,972.55

As the present value of the new lease is higher, you should not accept the deal.

b) The new lease should be such that its PV is equal to old deal.

Hence, the value of old lease in 9 months = 85,414.57 x (1 + 1%)^9 = $93,416.66

Indifference lease can be calculated using PMT function

N = 51, I/Y = 1%, PV = 93,416.66, FV = 0 => Compute PMT = $2,347.26

c) Now, the difference in lease for the first 9 months = 1,900, after which the difference in lease = -600 for the next 51 months. IRR for this stream of cash flows = 2.11% (monthly)

Annual rate = 25.36%

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