Starship Enterprises
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I figured out B, but cannot get A and C. Any help would be appreciated.
Jean-Luc is a financial executive with Starship Enterprises.
Although Jean-Luc has not had any formal training in finance or accounting, he has a "good sense" for
numbers and has helped the company grow from a very small company ($500,000 sales) to a large operation
($45 million in sales). With the business growing steadily, however, the company needs to make a
number of difficult financial decisions in which Jean-Luc feels a little "over his head." He therefore has
decided to hire a new employee with "numbers" expertise to help him. As a basis for determining whom
to employ, he has decided to ask each prospective employee to prepare answers to questions relating to
the following situations he has encountered recently. Here are the questions.
(a) In 2005, Starship Enterprises 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 January 1, 2006, Starship took possession of the leased property. The
20-year lease is effective for the period January 1, 2006, through December 31, 2025. Advance
rental payments of $800,000 are payable to the lessor (owner of facilities) on January 1 of each of
the first 10 years of the lease term. Advance payments of $300,000 are due on January 1 for each
of the last 10 years of the lease term. Starship has an option to purchase all the leased facilities
for $1 on December 31, 2025. At the time the lease was negotiated, the fair market value of the
truck terminals and freight storage facilities was approximately $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?
(b) Last year the company exchanged a piece of land for a non-interest-bearing note. The note is to
be paid at the rate of $12,000 per year for 9 years, beginning one year from the date of disposal
of the land. An appropriate rate of interest for the note was 11%. At the time the land was originally
purchased, it cost $90,000. What is the fair value of the note?
(c) The company has always followed the policy to take any cash discounts on goods purchased. Recently
the company purchased a large amount of raw materials at a price of $800,000 with terms
2/10, n/30 on which it took the discount. Starship has recently estimated its cost of funds at 10%.
Should Starship continue this policy of always taking the cash discount?
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Solution Summary
The solution explains how to evaluate lease vs purchase decision, find the fair value of note and the cost of not taking a cash discount.
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(a) In 2005, Starship Enterprises 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 January 1, 2006, Starship took possession of the leased property. The 20-year lease is effective for the period January 1, 2006, through December 31, 2025. Advance rental payments of $800,000 are payable to the lessor (owner of facilities) on January 1 of each of
the first 10 years of the lease term. Advance payments of $300,000 are due on January 1 for each of the last 10 years of the lease term. Starship has an option to purchase all the leased facilities for $1 on December 31, 2025. At the time the lease was negotiated, the fair market value of the truck terminals and freight storage facilities was approximately $7,200,000. If the company had borrowed the money ...
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