Question

**Part C!** Please show all work!

3. The Hub City Corporation is considering opening an office in a new market area that would allow it to increase its annual sales by $2.5 million. Cost of goods sold is estimated to be 40% of sales, and corporate overhead would increase by $300,000, not including the cost of either acquiring or leasing the space. The corporation will have to invest $2.5 million in office furniture, office equipment, and other up-front costs associated with opening a new office before considering the costs of owning or leasing the office space. A small office building could be purchased for sole use by the corporation at a total price of $3.9 million, of which $600,000 of the purchase price would represent land value, and $3.3 million would represent building value. The cost of the building would be depreciated over 39 years. The corporation is in a 30% tax bracket. An investor is willing to purchase the same building and lease it to the corporation for $450,000 per year for a term of 15 years, with the corporation paying all of the real estate operating expenses (estimated to be 50% of the lease payments). Estimates are that property value will increase over the 15-year lease term for a sale price of $4.9 million at the end of the 15 years. If the property were purchased, it would be financed with an interest-only mortgage for $2,730,000 at an interest rate of 10% with a balloon payment due at the end of 15 years. a. What is the return from opening the office building under the assumption that it is leased? b. What is the return from opening the office building under the assumption that it is owned? c. What is the return on the incremental cash flow from own ing leasing? versus

Answer 1

Return on the incremental cash flow from owning versus leasing :

calculate the difference owning and leasing cash flows before computing the return from incremental cash flows as follow as shown below :

Thanuja Koppuravuri AutoSum -A H Copy S to: Book1 - Microsoft Excel FILE HOME INSERT PAGE LAYOUT FORMULAS DATA REVIEW VIEW 4 X Cut Calibri -11 AA == Wrap Text Custom Paste **Format Painter BIU . A E Merge & Center - $ % 8.8 Clipboard Font Alignment Number H19 x fc =+H16+H17+18 A B C Formula Bar Ball E F G H I Conditional Format as Cell Formatting Table - Styles - Styles Insert Delete Format - Cells Fill Clear Sort & Find & Filter - Select - Editing K L M N O P Q R S Amount S . $ $ - $ - Particulars Sales Cost of goods sold Gross Income Less: Operating Expenses Business expense Real Estate Less : Lease payments Interest payment Depreciation Taxable income Less : Tax Income after tax Add: Depreciation Principal After-tax cash flow $ (450,000) $ 273,000 $ 84,615 $ 92,385 $ 27,715 $ 64,669 $ 84,615 $ 149,285 Sheet1 + READY 100% 1 Type here to search t e A O F -- + ENG 5:18 AM xwi_AxN IN 7/20/2019 1

Formula spreadsheet as follows

S to: FILE HOME INSERT PAGE LAYOUT 4 X Cut Calibri -11 Paste **Format Painter BIU . Clipboard Font FORMULAS DATA REVIEW AA == A E Book1 - Microsoft Excel VIEW Wrap Text General Merge & Center - $ % 8.8 Copy Thanuja Koppuravuri AutoSum-A H Fill Sort & Find & Clear Filter - Select - Editing Conditional Format as Cell Formatting Table Styles Styles Insert Delete Format - Cells Alignment Number A B C D E F G H I Amount 0 0 =+H5-H6 Particulars Sales Cost of goods sold Gross Income Less : Operating Expenses Business expense Real Estate Less : Lease payments Interest payment Depreciation Taxable income Less : Tax Income after tax Add : Depreciation Principal After-tax cash flow -450000 = 2730000*10% =3300000/39 =+H7-H9-H10-H11-H12-H13 =+H14*30% =+H14-H15 =+H13 =+H16+H17+H18 Sheet1 + READY AVERAGE: 21752.70769 COUNT: 32 SUM 326290.6154 HII 100% 1 Type here to search t e A O F ENG IN + 5:18 AM 7/20/2019 1

Hence, the after tax cash flow is $149,285 for 15 years.

The after tax cash flow for 15 years is $149,285 and the cash outlay is $ 1,170,000.

Now, calculate the internal rate of return with the help of spreadsheet.

Hence, the return from the incremental cash flow from owing versus leasing is 13.41%.