Question

The Black Knights Inc., a manufacturer of low-sugar, low-sodium, low-cholesterol TV dinners, would like to increase its market share in the Sunbelt. In order to do so, Black Knights has decided to locate a new factory in the Panama City area. Black Knights will either buy or lease a site depending upon which is more advantageous. The site location committee has narrowed down the available sites to the following three very similar buildings that will meet their needs. Building A: Purchase for a cash price of \(600,000, useful life 25 years. Building B: Lease for 25 years with annual lease payments of \)69,000 being made at the beginning of the year. Building C: Purchase for \(650,000 cash. This building is larger than needed; however, the excess space can be sublet for 25 years at a net annual rental of \)7,000. Rental payments will be received at the end of each year. The Black Knights Inc. has no aversion to being a landlord

Instructions In which building would you recommend that The Black Knights Inc. locate, assuming a 12% cost of funds?

Short answer

The best recommendation to The Black Knight Inc. is to locate to building C.

Step-by-step solution

Building A and Building B

Building A = $600,000

$\begin{array}{rcl}\mathrm{Building}\mathrm{B}\mathrm{lease}\mathrm{price}& =& \mathrm{Annual}\mathrm{lease}\mathrm{payment}\times \mathrm{PV}\mathrm{factor}\mathrm{of}\mathrm{annuity}\mathrm{due}\\ & =& 69,000\times 8.78432\\ & =& \$606,118\end{array}$

Building C

$\begin{array}{rcl}\mathrm{Building}\mathrm{C}& =& \mathrm{Purchase}\mathrm{price}-(\mathrm{Rent}\times \mathrm{PV}\mathrm{factor}\mathrm{of}\mathrm{annuity}\mathrm{due})\\ & =& 650,000-(7,000\times 7.84314)\\ & =& \$595,098.02\\ & & \end{array}$

The best alternative is building C as the PV of its net cost is the smallest.