The corporation has the opportunity to purchase an appropriate facility in suburban Chicago for $50,000,000 ($48,000,000 for the building; $2,000,000 for the land). If they purchase the facility, they would finance the acquisition via a 15-year mortgage at 4% interest with a $10,000,000 down payment (due at closing on January 2, 2018). The mortgage would be payable annually in arrears (i.e., the first mortgage payment would be due January 2, 2019). Real property taxes on the facility in 2018 would be $650,000 (the property taxes are also due annually in arrears with 2018 taxes due on January 2, 2019). Further, NT estimates that property taxes will increase annually at a rate of 5% in years subsequent to 2018.
As an alternative, a local real estate investor has offered to purchase the facility and lease it to NT. The investor would require NT to sign a 7-year non-cancelable lease with annual payments of $2,050,000 beginning January 2, 2018 (final lease payment due January 2, 2024). The lease
would also require NT to pay property taxes (as indicated above; first property tax payment due January 2, 2019; final property tax payment due January 2, 2025).
NT must decide whether to lease or buy the facility. In order to make a proper decision, NT will assume that it could sell the facility (building and land) on January 2, 2025 for $55,000,000. Under this scenario, they would make their final mortgage and property tax payments on January 2, 2025 and then sell the facility.
NT’s marginal tax rate is 34% and it uses a 6% discount rate to compute the present value of its future cash flows. For purposes of this analysis, assume that all cash flows occur at the beginning of the respective year.
1. Based on the above facts, which option (lease or buy) minimizes NT’s after-tax cost of
obtaining the facility?
2. Assume that during the 7-year period, Congress decides to enact a corporate alternative
capital gains tax rate of 25%. Would this change impact NT’s decision?
Support your conclusions with a comparison of the net present value of each option (include a
hard copy of your Excel spreadsheet) and a memo to Andy Brook, Chief Financial
Officer of NT, Inc. (one page, typed, single-spaced).