Practice Problem #54 FIN-335 Entrepreneurial Finance - Leasing v. Purchase Decision Purchase Scenario: Annie is trying to decide whether she should Lease or Purchase a commercial building for the next five years. Assuming that it was purchased for $100,000 plus $3,000 in closing costs the initial cash investment (equity) will be $28,000. The balance can be financed with a $75,000, 9.5%, 20-year mortgage. Likewise, is the fact that the building's depreciable value is $83,000 with a 31% marginal tax rate. Operation and Maintenance (O&M) for Year 1 equates to $3,500; estimated to increase 3% annually. In Annie's case specifically, annual operation and maintenance costs, depreciation, and interest are tax deductible. Thus, annual cash outflow associated with purchasing the building is the sum of O&M costs plus mortgage payment(s) minus deductible expense tax-shielding. Leasing Scenario: For the sake of an appropriate five-year lease comparison, assume that the property will be sold at the end of the fifth year. Estimate the after-tax cash flow from resale. For clarity, the property's estimated resale price at the end of Year 5 is $116,000; estimated after-tax cash flow from resale is $33,454 respectively. Leased for five years, where annual lease payments are due in advance, the first year's lease payment is $10,000. The following year's lease payments are scheduled to increase 3% annually. The tenant will pay all annual operating expenses; same as if the building is purchased. This in mind, and because the lease payments and the operating expenses are tax deductible, after-tax cost of leasing is the sum of the lease payment plus O&M costs minus the tax-shielding provided by the deductible expenses. #54 Cont. Based on the information presented, should Annie's business lease or purchase the commercial building. Support your decision by calculations and appropriate cash flow diagrams. Please also answer the following questions: 54a) Determine Annie's present value cost of owing. 54b) Determine Annie's present value cost of leasing. 54c) What is the net advantage of leasing if Annie were to choose this route