Question

The Novak 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, Novak has decided to locate a new factory in the Panama City area. Novak 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 $620,000, useful life 27 years.

Building B: Lease for 27 years with annual lease payments of $71,170 being made at the beginning of the year.

Building C: Purchase for $657,500 cash. This building is larger than needed; however, the excess space can be sublet for 27 years at a net annual rental of $6,200. Rental payments will be received at the end of each year. The Novak Inc. has no aversion to being a landlord.

In which building would you recommend that The Novak Inc. locate, assuming a 11% cost of funds? (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

		Net Present Value
Building A		$
Building B		$
Building C		$

The Novak Inc. should locate itself in which building?

Answer 1

	Net Present Value
Building A	620000
Building B	675265
Building C	604504
Novak Inc. should locate itself in Building C

Workings:
Building B:
Annual lease payments	71170
X PV factor	9.48806	=1+(1-(1.11)^-26)/0.11
Net Present Value	675265
Building C:
Net annual rental	6200
X PV factor	8.54780	=(1-(1.11)^-27)/0.11
Present value of rental	52996
Net Present Value	604504	=657500-52996