Jazz Quality Stores Inc., owns a nationwide chain of supermarkets. The company is going to open another store soon, and a suitable building site has been located in an attractive and rapidly growing area. In discussing how the company can acquire the desired building and other facilities needed to open the new store, Berns Pogi, the companys Vice president in charge of sales, stated, I know most of our competitors are starting to lease facilities rather than buy, but I just cant see the economics of it. Our development people tell me that we can buy the building site, put a building on it, and get all the store fixtures we need for just P850,000. They also say that property taxes, insurance and repairs would run P20,000 a year. When you figure that we plan to keep a site for 18 years, thats a total cost of P1,210,000. But then when you realize that the property will be worth at least a half million in 18 years, thats a net cost to us of only P710,000. What would it cost to lease the property?

I understand that Bigtime Insurance Company is willing to purchase the building site, construct a building and install fixtures to our specifications, and then lease the facility to us for 18 years at an annual lease payment of P120,000, replied Liza Barbers, the companys executive vice president.

Thats just my point, said Berns. At P120,000 a year, it would cost us a cool P2,160,000 over the 18 years. Thats 3 times what it would cost to buy and what would we have left at the end? Nothing! The building would belong to the insurance company!

Youre overlooking a few things, replied Liza. For one thing, the treasurers office says that we could only afford to put P350,000 down if we buy the property, and then we would have to pay the other P500,000 over four years at P175,000 a year. So there would be some interest involved on the purchase side that you havent figured in.

But that little bit of interest is nothing compared to over 2 million bucks for leasing, said Berns. Also, if we lease I understand we would have to put up an P8,000 security deposit that we wouldnt get back until the end. And besides that, we would still have to pay the yearly repairs and maintenance costs just like we owned the property. No wonder those insurance are so rich if they can swing deals like this. Well, Ill admit that I dont have all the figures sorted out yet, replied Liza. But I do have the operating cost breakdown for the building, which includes P7,500 annually for property taxes, P8,000 for insurance, and P4,500 for repairs and maintenance. If we lease, Bigtime will handle its own insurance costs and of course the owner will have to pay the property taxes. Ill put all this together and see if leasing makes any sense with our required rate of return of 16%. The president wants a presentation and recommendation in the executive committee meeting tomorrow. Lets see, development said the first lease payment would be due now and the remaining ones due in years 1-17. Development also said that this store should generate a net cash inflow thats well above the average for our stores.

Required:

1. Using the net present value approach, determine whether Jazz Quality Stores, Inc. should lease or buy the new facility. Assume that you will be making your presentation before the companys executive committee.

2. How will you reply in the meeting if Berns Pogi brings up the issue of the buildings future sales value?