Reference no: EM132440538

James Halabi is a financial executive with Sunland Company. Although James 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 ($440,000 sales) to a large operation ($40 million is sales). With the business growing steadily, however, the company needs to make a number of difficult financial decisions in which James Halabi 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 their answers to questions relating to situations he has encountered recently.

The following are the facts for the first question asked of prospective employees.

In 2019, Sunland Enterprises negotiated and closed a lease contract for newly constructed truck terminals and freight storage facilities. On January 1, 2020, Sunland took possession of the leased property. The 20-year lease is effective for the period January 1, 2020, through December 31, 2039. Advance rental payments of $700,000 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 $352,000 are due on January 1 for each of the last 10 years of the lease term. Sunland has an option to purchase all the leased facilities for $1 on December 31, 2039. At the time the lease was negotiated, the fair value of the truck terminals and freight storage facilities was approximately $6.30 million. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest.

Calculate the present value of the payments required of Sunland Enterprises under the lease agreement. 

Steps to be followed include:

1. Calculate the present value of the future cash flows for the advance rental payments of $700,000 for the period from January 1, 2020, through December 31, 2029. Hint: If using factor tables, because the lease payments are due at the beginning of each year, use the PV.2 regular annuity table for nine years and add the first payment of January 1, 2020, in your calculation.

2. Calculate the present value of the future cash flows for the advance rental payments of $352,000 for the 10-year period beginning January 1, 2030. Hint: If using factor tables, as in the first step, use the PV.2 regular annuity table for 10 years for the present value at January 1, 2029.

3. Take the calculation result of step 2 and arrive at the present value of that amount at January 1, 2020, by using nine years in your discount calculation.

4. Add the result of the first and third steps to arrive at the total cost of leasing.