Facts: Opportunity Landscaping Inc. (Opportunity) appreciatedyour assistance in preparing their 2018 Federal income tax return.As a result, they have come to you for advice on acquiring newfacilities for their manufacturing operations. They plan to takeaccess to their new facilities on January 2, 2020.

The corporation has the opportunity to purchase an appropriatefacility in suburban Chicago for $90,000,000 ($87,000,000 for thefactory building; $3,000,000 for the land). If they purchase thefacility, they would finance the acquisition via a 15-year mortgageat 3.5% interest with a $18,000,000 down payment (due at closing onJanuary 2, 2020). The mortgage would be payable annually in arrears(i.e., the first mortgage payment would be due January 2, 2021).Real property taxes on the facility in 2020 would be $1,000,000(the property taxes are also due annually in arrears with 2020taxes due on January 2, 2021). Further, Opportunity estimates thatproperty taxes will increase annually at a rate of 3% in yearssubsequent to 2020.

As an alternative, a local real estate investor has offered topurchase the facility and lease it to the corporation. The investorwould require Opportunity to sign a 7-year non-cancelable lease.The first lease payment of $3,700,000 would be due on January 2,2020. Lease payments will increase by 4% each year during the termof the lease with the final lease payment due on January 2, 2026.In addition, the lease would require a refundable deposit of$1,850,000 (payment due on January 2, 2020) against significantdamages to the facility; this deposit will be refunded to thecorporation on January 2, 2027 (when the occupancy ends andassuming that there are no significant damages).

Opportunity must decide whether to lease or buy the facility. Inorder to make a proper decision, the corporation will assume thatit could sell the facility (building and land) on January 2, 2027for $100,000,000. Under this scenario, they would make their finalmortgage and property tax payments on January 2, 2027 and then sellthe facility.

Opportunity’s Federal corporate tax rate is 21% and it uses a 7%discount rate to compute the present value of its future cashflows. For purposes of this analysis, assume that all cash flowsoccur at the beginning of the respective year.

Required:

1. Based on the above facts, which option (lease or buy)minimizes Opportunity’s after-tax cost of obtaining thefacility?

2. The local real estate investor has provided an option forOpportunity to consider. Under this option, a payment of$12,000,000 is due on January 2, 2020. If this payment is made, nodeposit is required and the payment is deemed to cover the firstthree years of the lease. On January 2, 2023, lease payments resumewith a $4,000,000 lease payment due (and a 4% increase in the leasepayment each year for the remainder of the lease term). Is this analternative that Opportunity should consider? Read and apply thematerials in text Section 6-2d as part of your analysis.

3. Opportunity’s CFO is not certain that the current 21% Federaltax rate will be maintained over the next seven years. She feelsthat an increase in the Federal rate to around 30% is likely atsome point in the near term. As a result, she would like to knowhow your analysis would be affected if the Federal income tax rateincreased to 30% on January 1, 2025.

I have calculated and found that the NPV for the lease option is($19,516,098). I have also used the PMT function on excel and foundthat the annual mortgage payments are $6,251,405 (15 years; $72million; 3.5% interest rate). I need help computing the NPV for thebuy option in order to decide which option is best.