Selena Cosmetics Corporation needs to acquire new facilities and is currently considering two opportunities: one involving a lease and the other, a purchase.
The first proposed facility can be leased by Selena for twelve years for $240,000 per year, payable at the beginning of each year. The facilities will be upgraded to Selena’s specifications before it moves in, and Selena will have no additional costs during the 12 years. Selena will have to make a deposit of $100,000 at the inception of the lease, which will be returned at the end of the 12th year if there is no unusual damage to the building structure or fixtures.
The second proposal requires that Selena purchase the land, construct the building, and purchase all of the fixtures itself. Selena would have to make a down payment of $400,000, and would pay off the balance over 5 years, at $300,000 per year (including interest). Selena would have to incur expenses of property tax ($40,000 per year) and maintenance ($16,000 per year)—both of which are paid at the end of each year. Insurance of $27,000 per year must be paid at the beginning of each year. The property is expected to have a useful life of 12 years, with a salvage value of $500,000 at the end of that time. Selena’s cost of funds is 10%
Required: Which opportunity should Selena pursue to acquire its new facilities? Explain carefully, and show your computations.