The Black Knights 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, Black Knights has decided to locate a new factory in the Panama City area. Black Knights 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 buildings.

Building A: Purchase for a cash price of $600,000, useful life 25 years.

Building B: Lease for 25 years with annual lease payments of $69,000 being made at the beginning of the year. Building

C: Purchase for $650,000 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $7,000. Rental payments will be received at the end of each year. The Black Knights Inc. has no aversion to being a landlord

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In which building would you recommend that The Black Knights Inc. locate, assuming a 12% cost of funds?

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TomShelby TomShelby · Answer 1 · 2019-10-19T22:49:00+02:00

Answer:

Option C has a lower present worth, thus his cost is lower than other options after, considering time value of money 595,098.03

Explanation:

Option A present worth 600,000

Option B present worth of annuity-due

[tex]C \times \frac{1-(1+r)^{-time} }{rate}(1+r) = PV\\[/tex]

C $ 69,000

time 25 years

rate 0.12

[tex]69000 \times \frac{1-(1+0.12)^{-25} }{0.12}(1+0.12) = PV\\[/tex]

PV $606,117.7906

Option C

650,000 cash payment less present value of the rental space:

[tex]C \times \frac{1-(1+r)^{-time} }{rate} = PV\\[/tex]

C $ 7,000

time 25 years

rate 0.12

[tex]7000 \times \frac{1-(1+0.12)^{-25} }{0.12} = PV\\[/tex]

PV $54,901.9738

650,000 - 54,901.97 = 595,098.03