Question

The Porter Beverage Factory owns a building for its operations. Porter uses only half of the building and is considering two options for the unused space. The Popcorn Store would like to purchase the half of the building that is not being used for $574,000. A 5% commission would have to be paid at the time of purchase. Salty Snacks would like to lease half of the building for the next five years at $151,500 each year. Porter would have to continue paying $31,100 of property taxes each year and $5,900 of yearly insurance on the property, according to the proposed lease agreement.

Determine the differential income or loss from the lease alternative. Enter a loss as a negative number.

Answer 1

SOLUTION

Alternate 1- If Popcorn store is sold

Cash flow form sale of building = $574,000

Commission to be paid = 5% * $574,000 = $28,700

Net cash flows if the building is sold = $574,000 - $28,700 = $545,300

Alternate 2 - If Popcorn store is leased for 5 years

Lease rentals for each year = $151,500

Property taxes to be paid each year = $31,100

Property insurance to be paid each year = $5,900

Net cash flows per year from leasing = $151,500 - $31,100 - $5,900 = $114,500

Net cash flows for 5 years from leasing = $114,500 * 5 years = $572,500

Differential income from lease alternative = Cash flow from sale - Cash flow from leasing

= $545,300 - $572,500 = $27,200

Note: As the rate of interest is not given in the problem, cash flows are not calculated in terms of their present values.