1) Almott, Inc. (AI) currently owns its corporate headquarters. It constructed this building 10 y... 1) Almott, Inc. (AI) currently owns its corporate headquarters. It constructed this building 10 years ago for a total cost of $12.5 million (this was AI’s initial basis in the building); 80 percent of this value was attributable to the building for tax purposes. They financed this property with a 30-year, 75-percent LTV mortgage at 8.00% interest. Next year AI expects to spend $1.7 million in operating expenses on the building; this cost is expected to rise by 2.50 percent per year. AI is considering a sale-leaseback of this building. They have found a buyer willing to pay $17 million for the property and lease it back to them on a 10-year lease with two 5-year options to renew. The initial base rent would be $40 per square foot (psf) based on 85,000 square feet of gross leasable area, with the rent scheduled to increase by $5.00 psf at each renewal date. The lease is a full-service (gross) lease. If AI sells the property, it will incur transaction costs of 4 percent of the gross sale price. AI expects to use this facility for 20 more years. If AI does not sell the property, it expects that the property will be worth $35 million 20 years from now, reflecting appreciation of approximately 2.88 percent per year. At that time, transaction costs from the sale would once again be 4 percent of the gross sale price. AI’s weighted average cost of capital is 15 percent and its corporate tax rate is 35 percent.
a) Using the above information, analyze the cash flows from the sale-leaseback and continuing to own alternatives. What is the NPV of each of these alternatives?
b) What is the IRR of the incremental costs of the sale-leaseback compared to continuing to own the property?
c) What non-financial factors might also be relevant for AI to consider in deciding whether to do a sale-leaseback?
d) Based on all of your above analysis, which alternative would you recommend for AI?