Question

A company is planning to move to a larger office and is trying to decide if the new office should be owned or leased. Cash flows for owning versus leasing are estimated as follows. Assume that the cash flows from operations will remain level over a 10 year holding period. If purchased, the company will invest $355,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due in year 10. The after-tax cash flow from sale of the property at the end of year 10 is expected to be $850,000. What is the incremental rate of return on equity to the company, if the property is owned instead of leased? ​ Own Lease Sales 1,000,000 1,000,000 Cost of goods sold 500,000 500,000 Gross income 500,000 500,000 Operating expenses: ​ ​ Business 130,000 130,000 Real estate 60,000 60,000 Lease payments 0 120,000 Interest 90,000 0 Depreciation 35,000 0 Taxable income 185,000 190,000 Tax 55,500 57,000 Income after tax 129,500 133,000 Plus: Depreciation 35,000 0 After-tax cash flow 164,500 133,000

Answer 1

Year	Incremental Cash Flows
0	$ (355,000)
1	$      31,500
2	$      31,500
3	$      31,500
4	$      31,500
5	$      31,500
6	$      31,500
7	$      31,500
8	$      31,500
9	$      31,500
10	$    881,500
IRR	15.56%

Year	Incremental Cash Flows
0	-355000
1	=164500-133000
2	=164500-133000
3	=164500-133000
4	=164500-133000
5	=164500-133000
6	=164500-133000
7	=164500-133000
8	=164500-133000
9	=164500-133000
10	=164500-133000+850000
IRR	=IRR(B2:B12)