The Earring Tree is a national chain of popularly priced fashion jewelry stores, situated in large regional shopping malls. It maintains a significant presence in the Northeast area, enjoying multiple location relations with many of the regional shopping center developers. Recently, The Earring Tree was approached by the landlord of a successful mall in the metropolitan Boston area, suggesting that the location presently occupied by The Earring Tree be relinquished, and to resituate into a far more desirable spot in the shopping center. The purpose of the request to relocate was based on placing another usage in the existing location that would be more suitable to the surrounding merchant retail mix. This particular landlord was one with whom The Earring Tree maintained a number of other retail locations. While on one hand, The Earring Tree saw the advantages of accommodating the landlords request (while the requirement to relocate was not a legally required provision in the lease), The Earring Tree would find itself in disfavor with the landlord if it bluntly refused .

Initially, The Earring Tree executed a ten year lease and presently has five years remaining before its normal expiry date. The landlord proposed that because of the more desirable spot and a larger footprint, it will increase the annual Rent by $10,000 over the original lease amount and that the lease would merely be amended to reflect both the new location and new rental, but with all other terms and conditions staying the same. It was agreed that the new location would in fact, net of the increase in Rent (from above), generate an increase in the annual after-tax cash flows of $15,000, bringing the projected annual after-tax cash flows to $65,000 for each of the remaining five years of the lease. (Assume that each of the first five years of the lease generated a $50,000 after-tax cash flow). It was estimated that the cost of building and re-fixturing the new location would be $100,000 since the existing store fixtures, signs, carpeting, etc. would not adaptable to the new location's lay-out.

When the landlord was requested to compensate The Earring Tree for the premature abandonment value of the leaseholds, fixtures, etc. (since none of the investment could be feasibly transferred to the new location) the landlord bluntly refused, suggesting that the projected after-tax cash flows was more than adequate to justify the costs associated with preparing the new location in the mall. The records indicated that the original store required an initial investment of $200,000 five years ago. Assume that all past and future cash flows are fixed at their stated amount. Assume also that the construction, re-fixturing, etc. would take place immediately before the commencement of the sixth year of the lease. Please disregard any issues relative to tax shields on the abandonment of the leasehold interests, as all tax considerations may be assumed to have been factored into "after tax cash flows". Also, you may disregard any tax considerations since the company is treated as an S Corporation and taxes are borne by the individual shareholders and not by the corporate entity.

If you were asked to counsel the firm, acting in their best interest, how would you suggest that they present the argument for reimbursement, to the landlord? What methodology would you use, and how much reimbursement should they be entitled to receive? The Earring Tree is a privately owned company, and as such, is unable to assign the markets perception of systematic risk to its performance, however, its formidable competitor, Claires Boutiques equity required return when viewing expansion, is approximately 16%. Or as a fall back, what about even a rent reduction for the remaining years of the existing lease? How would you, and why, prioritize your negotiating posture.