LAB 6

LAB6

Institutionaffiliated:

Dateof submission:

QUESTION1:

Table 1: Costs of Buying Office Space

Year

Down Payment (Opportunity Cost)

Annual Payment

Present Value (at d=10%)

0

-$500,000.00

&nbsp

-$165,500.00

1

&nbsp

-$1,560,000.00

-$1,418,196.00

2

&nbsp

-$1,622,400.00

-$1,340,751.36

3

&nbsp

-$1,687,296.00

-$1,267,665.48

Net Present Value of Costs (Discounting for Time):

-$4,192,112.84

Opportunitycost is compounded for the 3 years that the Part would be loosingother opportunities by opting the purchase option. $500,000 * (1 +0.1)^3 = $ 665,500 + $500,000 = $165,500.

Theannual payments are calculated through $5,000,000 – $ 500,000 (downpayment) = $4,500,000. The value is divided into 3 equal installmentsto complete full acquisition value. The installments are compoundedeach year with the increasing interest rate of 4% hence resulting tothe various expense values being discounted[ CITATION Gin10 l 1033 ].The Present value discounting factors are obtained from (1 + r)^-n.Year 1 Is discounted by 0.9091, year 2, 0.8264 and year 3, 0.7513.

QUESTION2:

Table 2: Benefits of Reselling Office Space

&nbsp

Resale Value

&nbsp

Year

Appreciation Scenario (.75)

Depreciation Scenario (.25)

Present Value (at d=10%)

0

$5,000,000.00

$5,000,000.00

&nbsp

1

$5,100,000.00

$4,900,000.00

&nbsp

2

$5,202,000.00

$4,802,000.00

&nbsp

3

$5,306,040.00

$4,705,960.00

&nbsp

EMV (Discounting for Risk):

$4,694,340.00

PV of Benefits (Discounting for Time):

$3,526,927.12

Eachyear the, the values are either increasing or reducing in the rategiven and an expected value is calculated on the average of the 3years so as to obtain one value comparing each probability option.The present value is considered for the third year only as there isonly one expected value figure.

QUESTION3:

Table 3: Costs of Leasing Office Space

Year

Down Payment (Opportunity Cost)

Annual Payment

Present Value (at d=10%)

0

-250,000.00

&nbsp

-332,750.00

1

&nbsp

-250,000.00

-227,275.00

2

&nbsp

-250,000.00

-206,600.00

3

&nbsp

-250,000.00

-187,825.00

Net Present Value of Costs (Discounting for Time):

-$621,700.00

Sincethe lease payments are equal in each month, similar/annual values arediscounted over the three years period to obtain their present value.

QUESTION4:

CBA Decision:

Cost of Buying

Cost of Leasing

&nbsp

-$665,185.72

-$621,700.00

Accordingto the excel worksheet and calculations conducted, the Party wouldbenefit more from leasing rather than buying as the down payment hasto be considered hence increases the cost value. The cost does notinclude depreciation which will continue to inflate the cost ofbuying the real estate.

QUESTION5:

OPTION 1: 5% DISCOUNT RATE

Table A1: Costs of Buying Office Space

Year

Down Payment (Opportunity Cost)

Annual Payment

Present Value (at d=10%)

0

-$500,000.00

&nbsp

-$78,812.50

1

&nbsp

-$1,560,000.00

-$1,418,196.00

2

&nbsp

-$1,622,400.00

-$1,340,751.36

3

&nbsp

-$1,687,296.00

-$1,267,665.48

Net Present Value of Costs (Discounting for Time):

-$4,105,425.34

Table A2: Benefits of Reselling Office Space

&nbsp

Resale Value

&nbsp

Year

Appreciation Scenario (.75)

Depreciation Scenario (.25)

Present Value (at d=10%)

0

$5,000,000.00

$5,000,000.00

&nbsp

1

$5,100,000.00

$4,900,000.00

&nbsp

2

$5,202,000.00

$4,802,000.00

&nbsp

3

$5,306,040.00

$4,705,960.00

&nbsp

EMV (Discounting for Risk):

$4,694,340.00

PV of Benefits (Discounting for Time):

$3,526,927.12

&nbsp

Table A3: Costs of Leasing Office Space

Year

Down Payment (Opportunity Cost)

Annual Payment

Present Value (at d=10%)

0

-250,000.00

&nbsp

-289,406.25

1

&nbsp

-250,000.00

-227,275.00

2

&nbsp

-250,000.00

-206,600.00

3

&nbsp

-250,000.00

-187,825.00

Net Present Value of Costs (Discounting for Time):

-$911,106.25

OPTION 1: 5% DISCOUNT RATE

CBA Decision:

Cost of Buying

Cost of Leasing

&nbsp

-$578,498.22

-$911,106.25

Ifthe discount does not affect the lease agreement, Buying optionbecomes more profitable but if the discount affects both options,lease agreement will continue being the better option[ CITATION Mat06 l 1033 ].In the above analysis, lease agreement has not being discounted withthe options evaluation therefore it becomes the unfavourableoption.

OPTION 2: 15% DISCOUNT RATE

Table B1: Costs of Buying Office Space

Year

Down Payment (Opportunity Cost)

Annual Payment

Present Value (at d=10%)

0

-$500,000.00

&nbsp

-$260,437.50

1

&nbsp

-$1,560,000.00

-$1,418,196.00

2

&nbsp

-$1,622,400.00

-$1,340,751.36

3

&nbsp

-$1,687,296.00

-$1,267,665.48

Net Present Value of Costs (Discounting for Time):

-$4,287,050.34

Table B2: Benefits of Reselling Office Space

&nbsp

Resale Value

&nbsp

Year

Appreciation Scenario (.75)

Depreciation Scenario (.25)

Present Value (at d=10%)

0

$5,000,000.00

$5,000,000.00

&nbsp

1

$5,100,000.00

$4,900,000.00

&nbsp

2

$5,202,000.00

$4,802,000.00

&nbsp

3

$5,306,040.00

$4,705,960.00

&nbsp

EMV (Discounting for Risk):

$4,694,340.00

PV of Benefits (Discounting for Time):

$3,526,927.12

&nbsp

OPTION 2: 15% DISCOUNT RATE

Table B3: Costs of Leasing Office Space

Year

Down Payment (Opportunity Cost)

Annual Payment

Present Value (at d=10%)

0

-250,000.00

&nbsp

-380,218.75

1

&nbsp

-250,000.00

-227,275.00

2

&nbsp

-250,000.00

-206,600.00

3

&nbsp

-250,000.00

-187,825.00

Net Present Value of Costs (Discounting for Time):

-$1,001,918.75

OPTION 2: 15% DISCOUNT RATE

CBA Decision:

Cost of Buying

Cost of Leasing

&nbsp

-$760,123.22

-$1,001,918.75

Thecost of buying is still lower in the 15% discount option on thecondition and assumption stated above that lease agreement does notget subjected to the discount factor. The only difference with the 5%discount option is the difference of the cost value in both option.

References

Posner, M. D. (2006). New Foundations of Cost-benefit Analysis. USA: Harvard University Press.

Rus, G. d. (2010). Introduction to Cost-Benefit Analysis: Looking for Reasonable Shortcuts. Massachusetts, USA: Edward Elgar Publishing.