A company is considering purchasing a large retail location. The retail site includes a large parking lot, loading dock facilities, and a warehouse-sized store suitable for sale both of both general merchandise and groceries. The retail site is in a prime location and costs $15 million. The company has arranged to borrow the entire $15 million purchase price from a local bank. When the transaction is completed, the company will have total reported assets of $65 million and total reported liabilities of $40 million.
The company has been approached by a real estate company that has offered to buy the property and then lease it to the company under a long-term, noncancelable lease contract. If the lease contract is carefully designed, neither the $15 million real estate asset nor the $15 million loan obligation will appear on the company's balance sheet. Why might the company want to enter into this lease contract rather than simply borrowing the money and buying the location itself?
There could be any number of reasons for leasing as opposed to buying, and not all of them have a direct or current effect on the financial statements. Here are some:
1. The company may not be interested in carrying such a huge value asset on their balance sheet. The nature of the business is retail, not real estate investments.
2. Adding an asset and corresponding liability to the balance sheet will alter certain financial ratios computed from balance sheet amounts. Those changes may negatively affect investor ...
The solution suggests nine discussion items to be considered in the decision to buy or lease a large retail location. The nine items discuss possible future consequences to either decision.