Question

The Riverbed Inc., a manufacturer of low-sugar, low-sodium, low-cholesterol TV dinners, would like to increase its market share in the Sunbelt. In order to do so, Riverbed has decided to locate a new factory in the Panama City area. Riverbed 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 very similar buildings that will meet their needs.

Building A: Purchase for a cash price of $611,800, useful life 26 years.

Building B: Lease for 26 years with annual lease payments of $70,900 being made at the beginning of the year.

Building C: Purchase for $655,200 cash. This building is larger than needed; however, the excess space can be sublet for 26 years at a net annual rental of $6,230. Rental payments will be received at the end of each year. The Riverbed Inc. has no aversion to being a landlord.

In which building would you recommend that The Riverbed Inc. locate, assuming a 12% cost of funds?

Answer 1

Net present value:
Building A	611800
Building B	626979
Building C	606010
The Riverbed Inc. should locate itself in Building C

Workings:
Building B:
Annual lease payments	70900
X PV factor of annuity due	8.84314	=1+(1-(1.12)^-25)/0.12
Net present value	626979
Building C:
Annual rental	6230
X PV factor of annuity due	7.89566	=(1-(1.12)^-26)/0.12
Present value of annual rental	49190
Net present value	606010	=655200-49190