A currently has a warehouse lease that calls for five annual payments of $120,000. The warehouse owner, who needs cash, is offering A a deal wherein A will pay $200,000 this year and then pay only $80,000 each of the remaining 4 years. (Assume that all lease payments are made at the beginning of the year.) Should A accept the offer if its required rate of return is 9%, and why?
What’s the PV of each?
A should choose the one with the lower PV.
You can just put the numbers into CF on your calculator and calculate the NPV for each scenario.
Alternately, you could calculate the NPV of switching (i.e. using the incremental cash flows of switching): CF0=120-200=(80); C01=40, etc…
If the NPV is positive, make the change.
NOTE: The NPV based on the incremental cash flows from making the change) will equal the difference in the NPVs of the two alternatives. It’s just a smaller number of calculations.