Solution 14.10
 
 

Advise the company on the course of action it should take    

Approach: This company must choose one of 3 options and as such this is a mutually exclusive decision scenario. Thus the NPV method is the most suitable technique to use in this situation.

Option 1 - Rent the land.

This will ensure an annual rental income of €10,000 for the 6 years. This must be discounted to get the present value of this annuity as follows using the annuity tables (12% year 6).

NPV

 

10,000  *  4.111

 

 

41,111

 

 

 

Option 2 - Work the land

The following are the relevant cash flows for this option discounted at 12% 

 

 

 

 

 

 

 

 

 

 

 

Year

C/F

DISC 12%

P.V

 

 

 

 

0

 

 

 

 

 

 

 

 

1

-10,000

0.893

 

-8930

 

 

 

 

2

20,000

0.797

 

15940

 

 

 

 

3

18,000

0.712

 

12816

 

 

 

 

4

15,000

0.636

 

9540

 

 

 

 

5

12,000

0.567

 

6804

 

 

 

 

6

9,000

0.507

 

4563

 

 

 

 

 

 

 

 

 

 

 

 

 

NPV

 

 

 

40733

 

 

 

 

 

 

 

 

 

 

 

 

 

Option 3 – Sell the remainder of the lease

In this scenario the lease can be sold immediately for €39,000. Thus the NPV of thie option is €39,000

Overall the option with the highest NPV is to rent the land. This option would also be less risky then option 2 as it would be based on a rental agreement whereas option 2 is based on forecast costs and revenue which may not be accurate. The least risky option is option 3 to sell the remainder of the lease although this has the lowest NPV. Overall the company should choose option 1