Question

Question 2. A metal fabrication company has a 5-year lease for their workshop in an industrial zone. Rent is $1,000 per month and there are 60 payments remaining. The next rent payment will be due in one month. The landlord who owns the workshop is planning to sell the property in a year, and he wants the tenants to pay a higher rent so he can sell the property at a higher price in the future. The landlord offered the metal fabrication company a new 5-year lease with no payments for the first 10 months and then monthly payments of $1,250 for the remaining 50 months. The lease cannot be broken, and the company has a WACC of 12% (1% per month). a.) Should the metal fabrication company accept the new lease? b.) If the company decided to bargain with the landlord, what is the monthly rent amount that the company should pay, with terms equal to the landlord’s offer? (First 10 months are free, then 50 equal monthly payments thereafter)

Answer 1

a..PV of the existing lease

1000*(1-1.01^-60)/0.01

44955

PV of the new lease=PV at mth.0 of PV at mth.10 of the new lease rentals

ie.PV at mth. 0 of (PV of monthly annuity of 1250 for 50 months at 1%p.m. at mth. 10)

ie.(1250*(1-1.01^-50)/0.01)/1.01^10=

44355

YES..

The metal fabrication company should accept the new lease

as the PV of rentals of the new lease < PV of the remaining payments of the existing lease.

44355< 44955

b. Equating the PV of the new lease , 44355 for payment over 60 months,

44355=Pmt.*(1-1.01^-60)/0.01

986.65

So,

the monthly rent amount that the company should pay, with terms equal to the landlord’s offer of First 10 months are free, then 50 equal monthly payments thereafter=

986.65

ie. $ 987