A Company Is Planning to Move to a Larger Office

question 20

Multiple Choice

A company is planning to move to a larger office and is trying to decide if the new office should be owned or leased. Cash flows for owning versus leasing are estimated as follows. Assume that the cash flows from operations will remain level over a 10 year holding period. If purchased, the company will invest $385,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due in year 10. The after-tax cash flow from sale of the property at the end of year 10 is expected to be $750,000. What is the incremental rate of return on equity to the company, if the property is owned instead of leased? $\begin{array}{r}\begin{array}{l}\\Sales\\Cost ~of ~goods ~sold\\Grass ~incame\\Operating ~expenses:\\Business\\Real~ estate\\Lease~ payments\\interest\\Depreciation\\Taxable~ income\\ Tax \\Income ~after ~tax\\ Plus: ~Depreciation\\ After-tax~ cash~ flow\\\end{array}\begin{array}{r}Own\\\hline1,000,000 \\500,000 \\500,000 \\\\130,000 \\60,000 \\0 \\90,000 \\35,000 \\185,000 \\55,500 \\129,500 \\35,000 \\164,500\end{array}\begin{array}{r}Lease\\\hline1,000,000 \\500,000 \\500,000 \\\\130,000 \\60,000 \\120,000 \\0 \\0\\190,000 \\57,000 \\133,000 \\0 \\133,000\end{array}\end{array}$

• A) 17.99%
• B) 13.26%
• C) 10.32%
• D) 12.62%

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Definitions:

Business Operation

The day-to-day activities involved in running a business, including production, marketing, and managing finances.

Terminated

Refers to the action of ending or concluding something, such as employment, contracts, or legal obligations.

Sole Proprietorships

A type of business owned and operated by one individual, where there is no legal distinction between the owner and the business.

Corporations

Legal entities that are separate and distinct from their owners, providing limited liability, easy transferability of shares, and perpetual existence.