Question

Splish Brothers 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, Splish Brothers has decided to locate a new factory in Kelowna, B.C. Splish Brothers 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 $605,000, useful life 25 years. Building B: Lease for 25 years with annual lease payments of $75,000 being made at the beginning of the year. Building C: Purchase for $655,000 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $7,900. Rental payments will be received at the end of each year. Splish Brothers Inc. has no aversion to being a landlord. Click here to view the factor table PRESENT VALUE OF 1. Click here to view the factor table PRESENT VALUE OF AN ANNUITY OF 1. Click here to view the factor table PRESENT VALUE OF AN ANNUITY DUE. Calculate the net present value of three buildings, assuming a 12% 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 $ 605000 Building B $ 728886 Building C $ 597307 In which building would you recommend that Splish Brothers Inc. locate? Splish Brothers Inc. should locate itself in Building B

Answer 1

The answer has been presented in the supporting sheet. For detailed answer refer to the supporting sheet.

A H 1 Answer Part 1) 3 Cash Price = $ 605000 4 5 So the correct answer is $ 605000 5 7 Part 2) 3 Present value of lease payments = annual lease payment present value annuity advance (25, 12%) 0 = 75000 *(((1-(1.12)^-24)/.12)+1) 1 = 75000* 8.78432 2 = $ 658824 3 4 so the correct answer is $ 658824 5 6 Part 3) 7 Present value 8 = Purchase cost-present value of rents 9 = 655000 - (7900 * ((1-(1.12)^-25)/12)) 0 = 655000 - 61961 C1 =$593039 2 3 So the correct answer is $ 593039 4 5 Part 4) 6 Building C should be selected as it has low present value of costs 7