Jackie Cochran, owner/manager of The French Bakery, must decide whether to accept the new lease arrangement proposed by the owner of the building from whom her firm leases space. The current lease requires a fixed payment of

$2,000 per month and 2% of annual sales in excess of $500,000. Sales of The French Bakery this year were $800,000. Jackie expects sales to increase by 10%

per year for the next 3 years, then level off for the remaining 2 years of the proposed 5-year lease. The proposed contract would require a fixed lease payment of $2,800 per month for 5 years. The French Bakery’s cost of capital is 12%.

Fixed payments are due at the beginning of each month, while variable payments are due on the last day of the year.

Required:

1. Determine whether Jackie should sign the proposed contract or stay with the current arrangement.

2. Assume that the proposed contract calls for an increase to $3,200 per month starting in year three. What would you recommend?