A company is planning to move to a larger office and is trying to decide if the new office should be owned or leased. Cash flows for owning versus leasing are estimated below. Assume that the cash flows from operations will remain level over a 10 year holding period. If purchased, the company will invest $385,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due in year 10. The after-tax cash flow from sale of the property at the end of year 10 is expected to be $750,000.

a. What is the incremental rate of return on equity to the company, if the property is owned instead of leased?

b. How should the firm decide based on your answer to part (a) and any other necessary information?

	Own	Lease
Sales	$920,000	$920,000
Less: Cost of goods sold	$460,000	$460,000
Gross income	$460,000	$460,000
Operating expenses
Business	$130,000	$130,000
Real estate	$55,000	$55,000
Lease payments	$0	$110,000
Mortgage interest payment	$90,000	$0
Tax depreciation	$35,000	$0
Taxable income	$150,000	$165,000
Less: Tax	$55,500	$57,000
Income after-tax	$94,500	$108,000
Plus: Depreciation	$35,000	$0
After-tax cash flow	$129,500	$108,000