Assume you are the Chief Finance Officer (CFO) of a publicly traded nationwide chain of Kwality food stores. Your company is considering opening a new store; a space is available in the Federation Square building in Melbourne. If you do not sign the lease today there is a high probability that someone else will.
The building management has offered you a choice oftwo leases:
Lease A is an open ended lease that will allow you to operate in the building without any options to break the lease. Underthis lease the new store will cost $9, 000 per month to operate including lease payments.
Lease B provides you with the once-off option to walk away from the lease with no financial penalties at two months. However, lease payments underthis lease will be an additional $1,000 per month.
You are facing two possibilities here: If everything going in the right direction, you can expect to generate $17, 000 per month in revenue in perpetuity. However, if your customers are mainly limited to morning and evening commuters, you expect the revenue to be halved. You estimate that there is an equal probability for each ofthe above revenue possibilities. The set up cost ofthe store will be $350, 000 and assume a required rate of return of9% per year.
As the CFO which lease would you sign? Provide calculations to support your answer.