Problem - Grouper Inc. owns and operates a number of hardware stores in the New England region. Recently, the company has decided to locate another store in a rapidly growing area of Maryland. The company is trying to decide whether to purchase or lease the building and related facilities.
Purchase: The company can purchase the site, construct the building, and purchase all store fixtures. The cost would be $1,860,400. An immediate down payment of $411,200 is required, and the remaining $1,449,200 would be paid off over 5 years at $352,200 per year (including interest payments made at end of year). The property is expected to have a useful life of 12 years, and then it will be sold for $504,200. As the owner of the property, the company will have the following out-of-pocket expenses each period.
Property taxes (to be paid at the end of each year) $41,610
Insurance (to be paid at the beginning of each year) 27,500
Other (primarily maintenance which occurs at the end of each year) 16,100
$85,210
Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Grouper Inc. if Grouper will lease the completed facility for 12 years. The annual costs for the lease would be $277,930. Grouper would have no responsibility related to the facility over the 12 years. The terms of the lease are that Grouper would be required to make 12 annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $109,700 is required when the store is opened. This deposit will be returned at the end of the 12th year, assuming no unusual damage to the building structure or fixtures.
Compute the present value of lease vs purchase. (Currently, the cost of funds for Grouper Inc. is 10%.)
Which of the two approaches should Grouper Inc. follow?