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Lease vs Buy

In 05 X company negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On Jan 1, 06 X company took possession of the leased property. The 20-yr lease is effective for the period jan 1/06 through dec 31,2025. Advance rental payments of $800,000 are payable to the lessor (owner of facilities) on Jan 1 of each of the first 10 years of the lease term. Advance payments of $300,000 are due on jan 1 for each of the last 10 years of the lease term. X company has an option to purchase all the leased facilities for $1 on Dec 31st, 2005. At the time the lease was negotiated, the fair market value of the money to purchase the truck terminals and freight storage facilities was approx. $7,200,000. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest. Should the company have purchased rather than leased the facilities?

Solution Preview

Note: the abbreviations have the following meanings
PVIF= Present Value Interest Factor
PVIFA= Present Value Interest Factor for an Annuity
They can be read from tables or calculated using the following equations
PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%
PVIF( n, r%)= =1/(1+r%)^n

Lease Payments:
1) 1st Jan 2006- 1st Jan 2015- 10 payments @ $800,000 per year
2) 1st Jan 2016- 1st Jan 2025- ...

Solution Summary

The solution evaluates a Lease vs Buy option.

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