Use the information in P3.7.
Data from P3.7
Dunn Inc. owns and operates a number of hardware stores in the Atlantic region. Recently, the company has decided to open another store in a rapidly growing area of Nova Scotia. The company is trying to decide whether to purchase or lease the building and related facilities. Currently, the cost of funds for Dunn Inc. is 10%. Purchase: The company can purchase the site, construct the building, and purchase all store fixtures. The cost would be $1,850,000. An immediate down payment of $400,000 is required, and the remaining $1,450,000 would be paid off over five years with payments of $350,000 per year (including interest payments made at the end of the year). The property is expected to have a useful life of 12 years, and then it will be sold for $500,000. As the owner of the property, the company will pay $56,000 in occupancy expenses at the end of each year.
Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Dunn Inc. if Dunn will lease the completed facility for 12 years. The annual payments would be $270,000. Dunn would have no responsibility related to the facility over the 12 years. The terms of the lease are that Dunn would be required to make 12 annual payments. (The first payment is to be made at the time the store opens and then one each following year.) In addition, a deposit of $100,000 is required when the store is opened. This deposit will be returned at the end of the twelfth year, assuming there is no unusual damage to the building structure or fixtures. Assume a 10% discount rate.
Instructions
a. Using Excel functions, calculate the present value of the net cash flows required of Dunn Inc. for (1) the purchase alternative and (2) the lease alternative. Hint: For the due for the lease payments, use type 1.
b. Which of the two alternatives should Dunn Inc. adopt?
