ACCOUNTING-Wyndham Stores operates a regional chain of upscale department stores.

QUESTION

Wyndham Stores
operates a regional chain of upscale department stores. The company is going
to open another store soon in a prosperous and growing suburban area. In
discussing how the company can acquire the desired building and other
facilities needed to open the new store, Harry Wilson, the company’s
marketing vice president, stated, “I know most of our competitors are
starting to lease facilities, rather than buy, but I just can’t see the
economics of it. Our development people tell me that we can buy the building
site, put a building on it, and get all the store fixtures we need for $14
million. They also say that property taxes, insurance, maintenance, and
repairs would run $200,000 a year. When you figure that we plan to keep a
site for 20 years, that’s a total cost of $18 million. But then when you
realize that the building and property will be worth at least $5 million in
20 years, that’s a net cost to us of only $13 million. Leasing costs a lot
more than that.”
“I’m not so sure,” replied
Erin Reilley, the company’s executive vice president. “Guardian Insurance
Company is willing to purchase the building site, construct a building and
install fixtures to our specifications, and then lease the facility to us for
20 years for an annual lease payment of only $1 million.”
“That’s just my point,” said
Harry. “At $1 million a year, it would cost us $20 million over the 20 years
instead of just $13 million. And what would we have left at the end? Nothing!
The building would belong to the insurance company! I’ll bet they would even
want the first lease payment in advance.”
“That’s right,” replied Erin.
“We would have to make the first payment immediately and then one payment at
the beginning of each of the following 19 years. However, you’re overlooking
a few things. For one thing, we would have to tie up a lot of our funds for
20 years under the purchase alternative. We would have to put $6 million down
immediately if we buy the property, and then we would have to pay the other
$8 million off over four years at $2 million a year.”
“But that cost is nothing
compared to $20 million for leasing,” said Harry. “Also, if we lease, I
understand we would have to put up a $400,000 security deposit that we
wouldn’t get back until the end. And besides that, we would still have to pay
all the repair and maintenance costs just like we owned the property. No
wonder those insurance companies are so rich if they can swing deals like
this.”
“Well, I’ll admit that I
don’t have all the figures sorted out yet,” replied Erin. “But I do have the
operating cost breakdown for the building, which includes $90,000 annually
for property taxes, $60,000 for insurance, and $50,000 for repairs and
maintenance. If we lease, Guardian will handle its own insurance costs and
will pay the property taxes, but we’ll have to pay for the repairs and
maintenance. I need to put all this together and see if leasing makes any
sense with our 12% before-tax required rate of return. The president wants a
presentation and recommendation in the executive committee meeting tomorrow.”
(Ignore income taxes.)

Click here to view.mhhe.com/connect/0077432320/Exhibit%208B-1.jpeg”>Exhibit 8B-1 and.mhhe.com/connect/0077432320/Exhibit%208B-2.JPG”>Exhibit 8B-2, to determine the appropriate discount
factor(s) using tables.

Required:

a.

Calculate the net
present value of the investment if the property is purchased.(Enter your answers in dollars not millions.
Round PV discount factor(s) to 3 decimal places. Any cash outflows should be
indicated by a minus sign. Round your intermediate calculations to the
nearest dollar amount.)

.0/msohtmlclip1/01/clip_image002.jpg”>

b.

Calculate the net present
value if the investment of the property is leased. (Enter your answers in dollars not millions.
Round PV discount factor(s) to 3 decimal places. Any cash outflows should be
indicated by a minus sign. Round your intermediate calculations to the nearest
dollar amount.)

.0/msohtmlclip1/01/clip_image004.jpg”>

c.

Should Wyndham Stores
lease or buy the new store?

Lease

Here is the
information forEXHIBIT 8B-1:
.0/msohtmlclip1/01/clip_image006.jpg”>

EXHIBIT 8B-2:
.0/msohtmlclip1/01/clip_image008.jpg”>

ANSWER:

REQUEST HELP FROM A TUTOR