Question

arkspur, Inc., a manufacturer of low-sugar, low-sodium, low-cholesterol TV dinners, would like to increase its market share in Western Canada. In order to do so, Larkspur has decided to locate a new factory in Kelowna, B.C. Larkspur will either buy or lease a site, depending upon which is more advantageous. The site location committee has narrowed down the available sites to the following three buildings.

Building A: Purchase for a cash price of $596,000, useful life 25 years.

Building B: Lease for 25 years with annual lease payments of $65,500 being made at the beginning of the year.

Building C: Purchase for $656,000 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $7,200. Rental payments will be received at the end of each year. Larkspur, Inc. has no aversion to being a landlord.

Calculate the net present value of three buildings, assuming a 10% cost of funds. (For calculation purposes, use 5 decimal places as displayed in the factor table provided. Round final answers to 0 decimal places, e.g. 5,275.)

		Net present value
Building A		enter a dollar amount rounded to 0 decimal places
Building B		enter a dollar amount rounded to 0 decimal places
Building C		enter a dollar amount rounded to 0 decimal places

In which building would you recommend that Larkspur, Inc. locate? Building A,B or C?

Answer 1

Solution :

Present value of Building A = Cash price of Building = $596,000

Present value of Building B = $65,500 * Cumulative PV Factor at 10% for 25 periods of annuity due

= $65,500 * 9.98474 = $654,000

Present value of Building C = Cash price- Present value of rental income = $656,000 - $7,200 * Cumulative PV Factor at 10% for 25 periods

= $656,000 - $7,200 * 9.07704 = $590,645

The Larkspur Inc. should locate itself in Building C.