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17 December, 09:36

You are considering purchasing a warehouse. The cost to purchase the warehouse is $491,000. Renting the equivalent space costs $19,400 per year.

Required:

1. If the annual interest rate is 6.5%, at what rate must rental cost increase each year to make the cost of renting comparable to purchasing? Assume that the rent will be paid at the end of each year.

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  1. 17 December, 13:11
    0
    2.55%

    Explanation:

    Let us think of the rental cost as a growing perpetuity. Therefore Using the formula for the present value of growing perpetuity, we want to find the growth rate g so that:

    $491,000=$19,400/6.5%-g

    Or

    Equivalent 6.5% - $19,400/$491,000

    Hence:

    6.5% - 3.95%

    =2.55%

    Therefore the rental costs must grow at a rate of 2.55% per year for the cost of renting to be comparable to the cost of purchasing the warehouse.
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