Question 6

Pharoah Inc. owns and operates a number of hardware stores in the New England region. Recently, the company has decided to locate another store in a rapidly growing area of Maryland. The company is trying to decide whether to purchase or lease the building and related facilities.

Purchase: The company can purchase the site, construct the building, and purchase all store fixtures. The cost would be $1,857,100. An immediate down payment of $404,100is required, and the remaining $1,453,000would be paid off over5years at $356,900per year (including interest payments made at end of year). The property is expected to have a useful life of11years, and then it will be sold for $505,800. As the owner of the property, the company will have the following out-of-pocket expenses each period.

Property taxes (to be paid at the end of each year)$40,990

Insurance (to be paid at the beginning of each year)27,040

Other (primarily maintenance which occurs at the end of each year)17,590

$85,620

Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Pharoah Inc. if Pharoah will lease the completed facility for11years. The annual costs for the lease would be $292,510. Pharoah would have no responsibility related to the facility over the11years. The terms of the lease are that Pharoah would be required to make11annual payments (the first payment to be made at the time the store opens and then each following year). In addition, a deposit of $91,100is required when the store is opened. This deposit will be returned at the end of the11thyear, assuming no unusual damage to the building structure or fixtures.

Click here to view factor tables

Compute the present value of lease vs purchase. (Currently, the cost of funds for Pharoah Inc. is10%.) (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

Lease Present value$

Purchase Present value$

Which of the two approaches should Pharoah Inc. follow?

Pharoah Inc. shouldpurchase or lease? the facilities