The Marigold 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, Marigold has decided to locate a new factory in the Panama City area. Marigold 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 very similar buildings that will meet their needs.Building A: Purchase for a cash price of $611,000, useful life 25 years.Building B: Lease for 25 years with annual lease payments of $71,370 being made at the beginning of the year.Building C: Purchase for $657,400 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $6,800. Rental payments will be received at the end of each year. The Marigold Inc. has no aversion to being a landlord. In which building would you recommend that The Marigold Inc. locate, assuming a 12% cost of funds? What is the net present value of Building A, B and C?

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Asked Nov 25, 2019
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The Marigold 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, Marigold has decided to locate a new factory in the Panama City area. Marigold 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 very similar buildings that will meet their needs.

Building A: Purchase for a cash price of $611,000, useful life 25 years.

Building B: Lease for 25 years with annual lease payments of $71,370 being made at the beginning of the year.

Building C: Purchase for $657,400 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of $6,800. Rental payments will be received at the end of each year. The Marigold Inc. has no aversion to being a landlord.

 

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

 

What is the net present value of Building A, B and C? 

 

 

 
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Expert Answer

Step 1

Present value is calculated to measure value of future money at present date. The money more value today than it will have in future. Therefore, present value of money is calculated to check the actual payment at present date.

Step 2

The decision of choosing among the three building will depend on the present value of their cost price. The present value will be calculated as follows:

Building A

Purchase price of building A: $611,000

As the payment is made one time at the time of purchase so, the purchase will be its net present value of cost. Therefore,

Net present value : $611,000

Step

Building B

Building B is taken on lease.

Annual lease payment: $71,370

Time period of lease: 25 years

Interest rate: 12%

Annuity factor for 25 years at 12%: 7.78432

Present value of lease payment is calculated as follows:

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annual lease payment x Present value =| (1 annuity factor for 25 years at 12%) = (S71,370 x (17.78432)) =($71,370 x8.78432) = $626,937

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Step 3

Building C

Building C is purchased on cash and rental income is received from extra space of building. So, present value of cost is calculated by deducting the present value of rental income from purchase price of building.

Pu...

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purchase price- Present value = (annual lease payment x annuity factor for 25 years at 12%) = (S657, 400-(S6,800x 7.78432)) = ($657,400-$53, 333) =$604,067

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