The Delicious Cake Factory owns a building for its operations. Delicious uses only half of the building and is considering two options that have been presented to them. The Candy Store would like to purchase the half of the building that is not being used for $550,000. A 7% commission would have to be paid at the time of purchase. Ice Cream Delight would like to lease the half of the building for the next 5 years at $100,000 each year. Delicious would have to continue paying $9,000 of property taxes each year and $1,000 of yearly insurance on the property, according to the proposed lease agreement.
Determine the differential income or loss from the lease alternative.
The differential income or loss from the lease alternative would be $400,000. This is calculated by subtracting the total cost of the lease (5 years x $100,000 + $9,000 + $1,000 = $600,000) from the total proceeds of the sale (550,000 - 7% commission = $510,500).
To determine the differential income or loss from the lease alternative, we need to calculate the total income and expenses associated with the lease option.
First, let's calculate the total income from the lease alternative:
Total Income from Lease = Annual Lease Payment * Number of Years
Total Income from Lease = $100,000 * 5
Total Income from Lease = $500,000
Next, let's calculate the total expenses associated with the lease alternative:
Total Expenses = Property Taxes + Insurance
Total Expenses = $9,000 + $1,000
Total Expenses = $10,000
Now, let's calculate the differential income or loss by subtracting the total expenses from the total income:
Differential Income or Loss = Total Income from Lease - Total Expenses
Differential Income or Loss = $500,000 - $10,000
Differential Income or Loss = $490,000
Therefore, the differential income from the lease alternative is $490,000.
To determine the differential income or loss from the lease alternative, we need to compare the costs and revenues associated with each option (selling to the Candy Store or leasing to Ice Cream Delight).
1. Selling to the Candy Store:
The Candy Store is offering to purchase the unused half of the building for $550,000. However, a 7% commission is required to be paid at the time of purchase.
Commission = 7% of $550,000 = $38,500
Net Proceeds from Sale = Purchase Price - Commission = $550,000 - $38,500 = $511,500
2. Leasing to Ice Cream Delight:
Ice Cream Delight would like to lease the half of the building for the next 5 years at $100,000 per year. However, Delicious would have to continue paying property taxes and insurance as stated in the lease agreement.
Annual Property Taxes = $9,000
Annual Insurance = $1,000
Annual Lease Revenue = $100,000
Net Annual Income from Lease = Lease Revenue - Property Taxes - Insurance
= $100,000 - $9,000 - $1,000 = $90,000
Total Net Income from Lease over 5 years = Net Annual Income x Number of Years
= $90,000 x 5 = $450,000
Now, to calculate the differential income or loss, we subtract the Total Net Income from Lease over 5 years from the Net Proceeds from Sale:
Differential Income/Loss = Net Proceeds from Sale - Total Net Income from Lease over 5 years
= $511,500 - $450,000 = $61,500
Therefore, the differential income from the lease alternative is $61,500.