A company is planning to move to a larger office and is trying to decide if the new office

should be owned or leased. Annual cash flows for owning versus leasing are estimated as

follows. Assume that the cash flows from operations will remain constant over a 10-year

holding period. If purchased, the company will invest $600,000 in equity and finance the

remainder with an interest-only loan that has a balloon payment due in year 10. The

companys marginal income tax rate is 30% and the after-tax cash flow from sale of the

property at the end of year 10 is expected to be $1,000,000. What is the incremental rate of

return on equity to the company, if the property is owned instead of leased?

Own 1,000,000 300,000 700,000 Lease 1,000,000 300,000 700,000 Sales Cost of goods sold Gross income Operating expenses: Business Real Estate Lease payments Interest Depreciation Taxable income Tax Income after tax Plus: Depreciation After-tax cash flow 150,000 40,000 145,000 0 0 150,000 40,000 0 90,000 50,000 370,000 111,000 259,000 50,000 309,000 365,000 109,500 255,500 0 255,500