Question

The Sheridan 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, Sheridan has decided to locate a new factory in the Panama City area. Sheridan 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 $615,800, useful life 28 years.

Building B: Lease for 28 years with annual lease payments of $71,850 being made at the beginning of the year.

Building C: Purchase for $655,900 cash. This building is larger than needed; however, the excess space can be sublet for 28 years at a net annual rental of $6,850. Rental payments will be received at the end of each year. The Sheridan Inc. has no aversion to being a landlord.

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In which building would you recommend that The Sheridan 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.)

Answer 1

Solution:

Present value of Building A = Cash Price = $615,800

Present value of Building B = $71,850 * cumulative PV factor at 11% for 28 periods of annuity due

= $71,850 * 9.54780 = $686,009

Present value of Building C = Cash Price - Present value of rental income

= $655,900 - $6,850 * Cumulative PV factor at 11% for 28 periods of ordinary annuity

= $655,900 - $6,850 * 8.60162

= $655,900 - $58,921 = $596,979

As present value of Building C is lowest, therefore The Sheridan Inc. locate Building C.