A prospective tenant has presented two lease proposals to the owner of an office building. The first alternative has a five-year term and a contract rate of $16.00 per square foot in the first year of the lease. The rental rate then steps up 3 percent per year over the remainder of the lease term. So, for example, the rental rate in year 2 (months 13 - 24) would be $16.48. The second lease alternative is also a five-year lease with an initial contract rate of $16.00 per square foot. However, the rental rate on this lease is indexed to inflation with adjustment made at the beginning of each year based on the actual rate of inflation in the previous year. The owner of the office property projects that inflation will run at a rate of 3 percent per year over the five-year lease term.
a. What are the owner's projected payments over the five-year term for the two alternatives?
b. Which option is the owner likely to prefer and why?