A store has 5 years remaining on its lease in a mall. Rent is $1,900 per month, 60 payments remain, and the next payment is due in 1 month. The mall's owner plans to sell the property in a year and wants rent at that time to be high so that the property will appear more valuable. Therefore, the store has been offered a "great deal" (owner's words) on a new 5-year lease. The new lease calls for no rent for 9 months, then payments of $2,600 per month for the next 51 months. The lease cannot be broken, and the store's WACC is 12% (or 1% per month). A. Should the new lease be accepted? (Hint: Be sure to use 1% per month.)

B. If the store owner decided to bargain with the mall's owner over the new lease payment, what new lease payment would make the store owner indifferent between the new and the old leases?

C. The store owner is not sure of the 12% WACC. It could be higher or lower. At what nominal WACC would the store owner be indifferent between the two leases?

A. Should the new lease be accepted?

No, since the PV of the new deal is much higher than the PV of the current deal.

current deal's PV = $1,900 x annuity factor (1%, 60 periods) = $1,900 x 44.40459 = $84,368.72

new deal's PV:

$2,600 x annuity factor (1%, 51 periods) = $2,600 x 39.79814 = $104,475.16

$104,475.16 / 1.01⁹ = $95,525.80

B. If the store owner decided to bargain with the mall's owner over the new lease payment, what new lease payment would make the store owner indifferent between the new and the old leases?

To determine which lease value would make the store owner indifferent between the two options, we have to determine the future value of the first 9 payments that are not paid. Then that value should be equal to the present value of the increase in rent for the next 51 months:

step 1, calculate future value of 9 payments:

F V  = payment x [(1 + r)ⁿ  - 1] / r

F V  = $1,900 x [(1 + 0.01)⁹  - 1] / 0.01 = $17,800

step 2, calculate the present value of the increase in rent:

PV = payment / {1 - [1 / (1 + r)ⁿ] / r}

PV = $19,674 / ({1 - [1 / (1 + 0.01)⁵¹]} / 0.01) = $17,800 / 39.8 = $447.24

the new lease payment for which the store owner would be indifferent = $1,900 + $447.24 = $2,347.24

C. The store owner is not sure of the 12% WACC. It could be higher or lower. At what nominal WACC would the store owner be indifferent between the two leases?

in order to determine at what WACC would the store owner be indifferent between both alternatives, I used an excel spreadsheet to determine the IRR of the differential amount between both lease amounts:

periods 1 - 9 = -$1,900

periods 10 - 50 = $700

this results in a monthly IRR = 2.74%

WACC = 2.74% x 12 = 32.88%