A company is assessing whether to open a new office that would allow an increase of annual sales by $1.5 million. The projected cost of goods sold is estimated to be 30 per cent of sales and company overhead would increase by $180,000 not including the cost of either acquiring or leasing office space. The company will also have to invest $1.2 million in office furniture, office equipment, and other up-front costs associated with opening the new office before considering the costs of owning or leasing the office space.

A small office building could be purchased for sole use by the company at a total price of $2 million, of which $500,000 of the purchase price would represent land value, and $1.5 million would represent the value of the building. The cost of the building would be depreciated over 30 years. The company tax rate is 30%.

An investor is willing to purchase the same building and lease it to the company for $200,000 per year for a term of 5 years, with the company paying all property outgoings which are estimated to be 40 per cent of the lease payments.

It is estimated that the property value will increase to $2.6 million at the end of the 5 years. If the property is purchased, it would be financed with an interest-only mortgage for $1.05 million at an interest rate of 7 per cent with a balloon payment due after 5 years. Capital gain tax is estimated to be $250,000. Assume all cash flows occur at the end of the year and discount rate is 9 per cent.

Discounted factor of 9 per cent can be found at Table 2 above of this paper. You must show all workings.

a) What is the net present value from opening the new office under the assumption that the company leases the office space?

b) What is the net present value from opening the new office under the assumption that the company purchases the office space?

c) What is the net present value on the incremental cash flow from owning versus leasing (The investors perspective)?

d) In general, what other factors might the company consider before deciding whether to lease or own?

WORKINGS MUST BE SHOWN - NOT EXCEL