Question

“The Designers” an international furniture making company wants to expand its business in Pakistan by introducing its specialized Teak-wood rocking chair. For this purpose, the company needs a warehouse to store the goods. The company has forecasted the demand of the chair to be 4000 units each year for the next four years. The revenue generated by the company is Rs.20000 per chair. A single chair takes up an area of about 10 square feet.

Swift Logistics, a warehousing expert company, has offered to provide its services for storage of the goods. It has presented two alternatives: either to Lease the warehouse at the rate of Rs.10000 per 100 square feet or have it on Spot Market rate which is Rs.15000 per 100 square feet.

Answer 1

Answer:

I would consider consider leasing since the present value to be gained from leasing ($216,978,355.60) is greater compared to the present value if the spot rate is considered ($214,676,191.10).

Explanation:

Step 1: Total revenue per year if the demand is met

Total revenue per year=revenue per chair×number of chairs per year

where;

revenue per chair=Rs.20,000

number of chairs per year=4,000 units

replacing;

Total revenue per year=(20,000×4,000)=$80,000,000

Step 2: Determine the net revenue per year for Leasing

Net revenue=total revenue-total cost for leasing

total cost for leasing=cost per chair per square feet×area per chair×number of chairs

where;

cost per chair per square feet=10,000/100=$100

area per chair=10 square feet

number of chairs=4,000

replacing;

total cost for leasing=100×10×4,000=$4,000,000

Net revenue=80,000,000-4,000,000=76,000,000 per year

Step 3: Determine the present value of the net revenue per year for Leasing

Year       Future cash flow            Present cash flow                 Amount

 1            76,000,000               76,000,000/{(1+0.15)^1}         66,086,956.52

 2           76,000,000               76,000,000/{(1+0.15)^2}         57,466,918.71

 3           76,000,000               76,000,000/{(1+0.15)^3}         49,971,233.66

 4           76,000,000               76,000,000/{(1+0.15)^4}         43,453,246.67

Total present value of the future net revenue for leasing=(66,086,956.52+57,466,918.71+49,971,233.66+43,453,246.67)=

$216,978,355.60

Step 4: Determine the present value for the cost for spot Market rate

Since the spot market rate is paid once;

Total cost=(15,000/100)×10×4,000=$6,000,000

Total cost in four years=6,000,000×4=$24,000,000

Present value of spot rate cost=24,000,000/{(1+0.15)^4}=$13,722,077.89

Step 4: Determine the present value of the revenue per year

Year       Future cash flow            Present cash flow                 Amount

 1            80,000,000               80,000,000/{(1+0.15)^1}         69,565,217.39

 2           80,000,000               80,000,000/{(1+0.15)^2}         60,491,493.38

 3           80,000,000               80,000,000/{(1+0.15)^3}         52,601,298.59

 4           80,000,000               80,000,000/{(1+0.15)^4}         45,740,259.65

Present value of Total revenue=69,565,217.39+60,491,493.38+52,601,298.59+45,740,259.65=

$228,398,269

Step 5: Determine the present value of the net revenue per year for sport rate

Net present value=(228,398,269-13,722,077.89)=$214,676,191.10

I would consider consider leasing since the present value to be gained from leasing ($216,978,355.60) is greater compared to the present value if the spot rate is considered ($214,676,191.10).