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Qwestry Property Group purchased a warehouse building for $1
Qwestry Property Group purchased a warehouse building for $1.2 million on June 15 2016. On the same date, the building was leased to an importer for a four-year term at an agreed rent of $45,000 per month. It is expected that rents can be increased by $5,000 per month if the lease is extended (on June 15 2020). Maintenance costs on the building are $5,000 per month and expected to remain at this level. Management is also considering an option to convert the building to a shopping centre which it will own and operate. If management takes up this option the lease will not be extended, construction will commence on June 15 2020, will cost $2 million and is expected to be completed in six months. The construction would be financed completely using Qwestry’s internal funds and therefore there would be no need for external financing. Once completed, rents from the shopping centre are expected to be $95,000 per month and maintenance costs will be $30,000 per month.
Management must decide on whether to convert the building to a shopping centre or to continue with the current lease.
Required:
Identify the information that is relevant to management’s decision and justify your answer. Also identify the information is irrelevant to management’s decision and justify your answer.
Do not perform any calculations
Expert Solution
The construction cost for the shopping center $2 million.
Maintenance costs on the building of $5,000 per month and maintenance costs on the shopping center of $30,000 per month.
All the above , are relevant since they are future costs and they differ between the two alternatives of extending the building lease or converting it into a shopping center.
The purchase cost of the warehouse building of $1.2 million.
The four-year term lease rentals.
These costs are irrelevant since they are sunk costs/revenues that will not change since the decision is to be made for the period after the four-year lease term.
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