Cecil Copeland, owner of Copeland’s Place, must renew his 5-year building lease in three months. For the past 5 years, he has paid the lessor $4,000 per month. The lessor has suggested that Cecil should consider a variable lease of 5% of sales. Copeland’s Place had total sales of $900,000 in 20X5 and expects total sales of $940,000 this year (19X6). Further, Cecil expects total sales to increase by 10% per year beginning in 20X7. Assume Copeland’s Place has a marginal tax rate of 30%.
Required:
1. Calculate the amount of sales at which the lease expense will be the same regardless of whether the lease is fixed or variable as proposed above.
2. Determine whether Cecil should agree to the proposed arrangement or stay with the $4,000 per month.
3. Assume Cecil makes the wrong decision. Calculate the after-tax cost of the error over the next 5 years