Nesabel 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 attractive and rapidly growing area. In discussing how the company can acquire the desired building and other facilities needed to open the new store, Sam Gonzales, 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 P85,000,000. They also say that property taxes, insurance, and repairs would run P2,000,000 a year. When you figure that we plan to keep a site for 18 years, thats a total of P121,000,000. But then when you realize that the property will be worth at least P50 million in 18 years, thats a net cost of P71,000,000. What would it cost to lease the property?

I understand that Maridom Insurance Company is willing to purchase the building site, construct the building and install fixtures to our specifications, and then lease the facility to us for 18 years at an annual lease payment of P12,000,000, replied Cayden Gomez, the company Executive Vice President.

Thats just my point, said Sam. At P12,000,000 a year, it would cost us a cool P216,000,000 over the 18 years. Thats three times what it 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 Cayden. For one thing, the treasurers office says that we could only afford to put P35,000,000 down if we buy the property, and then we would have pay the other P50 million off over four years at P17,500,000 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 P200 billion for leasing, said Sam. Also, if we lease, I understand we would have to put up an PP800,000 security deposit that we wouldnt get back until the end . And besides that, we would still have to pay all the yaerly repairs and maintenance costs just like we owned the property. No wonder those insurance companies are so rich if they can swing deals like this.

Well, Ill admit that I dont have all the figures sorted out yet, replied Cayden. But I do have the operating cost breakdown for the building, which includes the P750,000 annually for the property taxes, P800,000 for the insurance, and P450,000 for the repairs and maintenance. If we lease, the insurance company will handle its own insurance costs and of course the owner will have to pay for 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, our development people 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 (Ignore income taxes):

1. Using the net present value approach, determine whether Nesabel 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 Sam Gonzales brings up the issue of the buildings future sales value?

This has to be submitted on Friday, July 21, in good form (project proposal)