Real Estate and Capital Structure Decisions – Lease-Versus-Buy Analysis

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Table of Contents

I. Introduction 3
Overview 3
The Company 3
Situational Analysis 3
II. Case Analysis 3
Considerations 3
Purchasing 4
Recommendation 5
III. Summary & Conclusions 5
IV. References 5
V. Appendix 6

I. Introduction
Overview
This case provides real estate market data for the analysis of an office lease-or-buy decision. The case demonstrates what is known as the “leasing puzzle” – the answer simply being that the two forms of financing are not cost equivalent in the presence of capital market imperfections, despite both being credit forms. The case presents two opposing anecdotes: one about a trading company that bought its office and profited hugely from this decision as the market and capital values move
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Nevertheless, we will determine the answer entirely by assumptions about interest rates and rental market dynamics.
II. Case Analysis
Please answer all the case questions in the case (if any) and the following aspects.
Considerations
1. What factors should Jonathan consider when making a buy or lease decision?
There are benefits and risks involved in both buying and leasing. The decision would have different effects on the company. However, we will decide based on a comparison between the net present value of both borrowing-to-buy alternative and the cash flows associated with the leasing alternative. Factors that Mr. Young needs to consider in the lease-versus-buy decision are the effects on the company’s growth opportunities in addition to the cost and the risks involved in each alternative.
Buy Decision
The risks in buying include the fluctuation of the value of the property depending on the economic situation. In a financial crisis, currency value could depreciate, making investors pull out of property investment, thus, decreasing property prices. The benefits of owning include the potential for price appreciation, the ability to stay in the same location and conduct business over the long run, and the tax benefits of buying.
Buying office space would have to be financed either by debt or by equity. Financing the purchase through debt would increase the company’s debt ratio and may decrease the company’s ability to obtain more credit for

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