Top-Quality Stores, Inc., owns a nationwide chain of supermarkets. The company is going to open anotherstore soon, and a suitable building site has been located in an attractive and rapidly growing area. Ind iscussing how the company can acquire the desired building and other facilities needed to open the newstore, Sam Watkins, the company’s vice president in charge of sales, stated, “I know most of our competitors are starting to lease facilities rather than buy, but I just can’t see the economics of it. Our developmentpeople tell me that we can buy the building site, put a building on it, and get all the store fixtures we needfor just $850,000. They also say that property taxes, insurance, and repairs would run $20,000 a year.When you figure that we plan to keep a site for 18 years, that’s a total cost of $1,210,000. But then whenyou realize that the property will be worth at least a half million in 18 years, that’s a net cost to us of only$710,000. What would it cost to lease the property?”“I understand that Beneficial Insurance Company is willing to purchase the building site, construct abuilding and install fixtures to our specifications, and then lease the facility to us for 18 years at an annuallease payment of $120,000,” replied Lisa Coleman, the company’s executive vice president.“That’s just my point,” said Sam. “At $120,000 a year, it would cost us a cool $2,160,000 over the 18years. That’s three times what it would cost to buy, and what would we have left at the end? Nothing! Thebuilding would belong to the insurance company!”“You’re overlooking a few things,” replied Lisa. “For one thing, the treasurer’s office says that wecould only afford to put $350,000 down if we buy the property, and then we would have to pay the other$500,000 off over four years at $175,000 a year. So there would be some interest involved on the purchaseside that you haven’t figured in.”“But that little bit of interest is nothing compared to over 2 million bucks for leasing,” said Sam.“Also, if we lease I understand we would have to put up an $8,000 security deposit that we wouldn’t getback until the end. And besides that, we would still have to pay all the yearly repairs and maintenance costsjust like we owned the property. No wonder those insurance companies are so rich if they can swing dealslike this.”“Well, I’ll admit that I don’t have all the figures sorted out yet,” replied Lisa. “But I do have theoperating cost breakdown for the building, which includes $7,500 annually for property taxes, $8,000 forinsurance, and $4,500 for repairs and maintenance. If we lease, Beneficial will handle its own insurancecosts and of course the owner will have to pay the property taxes. I’ll put all this together and see if leasingmakes any sense with our required rate of return of 16%. The president wants a presentation and recommendation in the executive committee meeting tomorrow. Let’s see, development said the first lease payment would be due now and the remaining ones due in years 1–17. Development also said that this storeshould generate a net cash inflow that’s well above the average for our stores.”Required:(Ignore income taxes.)1. Using the net present value approach, determine whether Top-Quality Stores, Inc., should lease or buythe new facility. Assume that you will be making your presentation before the company’s executivecommittee.2. How will you reply in the meeting if Sam Watkins brings up the issue of the building’s future sales value?
Top-Quality Stores, Inc., owns a nationwide chain of supermarkets. The company is going to open another
store soon, and a suitable building site has been located in an attractive and rapidly growing area. In
d iscussing how the company can acquire the desired building and other facilities needed to open the new
store, Sam Watkins, the company’s vice president in charge of sales, stated, “I know most of our competitors are starting to lease facilities rather than buy, but I just can’t see the economics of it. Our development
people tell me that we can buy the building site, put a building on it, and get all the store fixtures we need
for just $850,000. They also say that property taxes, insurance, and repairs would run $20,000 a year.
When you figure that we plan to keep a site for 18 years, that’s a total cost of $1,210,000. But then when
you realize that the property will be worth at least a half million in 18 years, that’s a net cost to us of only
$710,000. What would it cost to lease the property?”
“I understand that Beneficial Insurance Company is willing to purchase the building site, construct a
building and install fixtures to our specifications, and then lease the facility to us for 18 years at an annual
lease payment of $120,000,” replied Lisa Coleman, the company’s executive vice president.
“That’s just my point,” said Sam. “At $120,000 a year, it would cost us a cool $2,160,000 over the 18
years. That’s three times what it would cost to buy, and what would we have left at the end? Nothing! The
building would belong to the insurance company!”
“You’re overlooking a few things,” replied Lisa. “For one thing, the treasurer’s office says that we
could only afford to put $350,000 down if we buy the property, and then we would have to pay the other
$500,000 off over four years at $175,000 a year. So there would be some interest involved on the purchase
side that you haven’t figured in.”
“But that little bit of interest is nothing compared to over 2 million bucks for leasing,” said Sam.
“Also, if we lease I understand we would have to put up an $8,000 security deposit that we wouldn’t get
back until the end. And besides that, we would still have to pay all the yearly repairs and maintenance costs
just like we owned the property. No wonder those insurance companies are so rich if they can swing deals
like this.”
“Well, I’ll admit that I don’t have all the figures sorted out yet,” replied Lisa. “But I do have the
operating cost breakdown for the building, which includes $7,500 annually for property taxes, $8,000 for
insurance, and $4,500 for repairs and maintenance. If we lease, Beneficial will handle its own insurance
costs and of course the owner will have to pay the property taxes. I’ll put all this together and see if leasing
makes any sense with our required rate of return of 16%. The president wants a presentation and recommendation in the executive committee meeting tomorrow. Let’s see, development said the first lease payment would be due now and the remaining ones due in years 1–17. Development also said that this store
should generate a net
Required:
(Ignore income taxes.)
1. Using the
the new facility. Assume that you will be making your presentation before the company’s executive
committee.
2. How will you reply in the meeting if Sam Watkins brings up the issue of the building’s future sales value?
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 2 images
