Holly Molseed, owner of Holly’s Hotel, desires to know which 5-year lease arrangement is most desirable. Her options are as follows:

1. Fixed rent of $11,000 per month, due at the beginning of each month 2. Variable rent of 5% of sales, due at the end of each month 3. Fixed rent of $5,500 per month (due at the beginning of each month) and 2.5% of sales (due at the end of each year)

Holly projects the hotel’s sales for the next 5 years as follows:

Year Sales 1 $2,200,000 2 $2,400,000 oS $2,700,000 4 $3,000,000 5 $3,400,000 Assume monthly sales during a year are the same. Holly’s cost of capital is 12%.

Required:

Identify which rental arrangement is most desirable and explain why.