Real Estate and Capital Structure Decisions - Assignment Example

1. What are the main decisions to be made? Jonathan Young, the CEO of Sunny Trading Company Limited (STL), has to decide whether to continue rentingan office space or to purchase its own. A ten percent increase of the rent would indeed, bring about financial constraint to the trading company. The situation has the need to evaluate each issue’s strength and weak points to be able to come up with a decision that will be most likely to bring about the best possible result. The company has to choose whether to wrestle financial limitation that would be brought out by purchasing, or to just try to come up with alternatives to sustain the increased need for rent. 2. What factors should Jonathan consider when making a buy or lease decision? Several factors need to be considered when one is contemplating with a major decision making on buying an office space. One significant factor is the stability and probability of company expansion. To achieve a clearer view on this, research and study to determine feasibility is suggested. It will not be wise to assume future expansion, and neither probable bankruptcy based on its present position. If the study proves to be promising, that the company will most likely to expand in 2-3 years, the idea of buying a space could then be possible---but it still might not be the best option. Company expansion may not even mean an extension of the same space. It would sometimes be practical, and this is what most businessmen prefer, to rent a space from a different area. This aims to win a different market and could then maximize company profits, or at times, if it is not a marketing company, this option will give its clients an option on which office is more accessible. Another factor is the present company financial status on the STL’s immediate needs. Having a twenty full-time staff, STL could then be considered as a small enterprise, and its financial statements show that STL is not earning a quite impressive profit; in fact, the statement indicates that the company will be immediately affected of the lease rent increase. The price of the space that the company may consider to purchase is also a dynamic aspect. This must be compared against the lease price to determine which one could be considered practical. Below is an illustration of a basic computation to determine the distinction on the lease expense and the purchase option. The trading company is currently paying an annual amount of HK$970,000 or HK$80,833.333 every month, whereas, an additional ten percent would require the company to spend HK$1,067,000 every year or HK$88916.667 each month. This amount, when multiplied by 10, would make the company an allotment of HK$10, 670,000. Please note the possibility of another increase for the lease. This would be dependent on the length of time of the contract, if STL has a 10-year lease contract it is not likely to endure another price rise. The amount, however, was multiplied by ten, for the anticipation of a ten- year-mortgage should the company decide to purchase its own space. Lease expense: HK$ 970,000 x 10% increase = HK$ 1,067,000 Lease expense (10 years): HK$1, 067,000 x 10 = HK$10,670,000 Purchase Price : HK$ 8,600,000 + interest (Through a ten-year-mortgage) The interest would depend on the market and economy; however, it is evident that the purchase price does not have a great difference in amount. The purchase price plus interest, definitely, would be higher than the lease price; but it should be noted that the purchase would be an investment; not a company expenditure. This plays a major role on the STL decision on whether to purchase a space or to rent. However, Jonathan Young should not be overwhelmed by this and immediately decide to buy an office space. Buying one, as practical as the result may seem, is far more complicated than renting one. These factors are the ones that are most important, other issues still need to be considered such as a thorough study of the market and economy for these play a vital role on asset depreciation or appreciation. 3. How will the purchase decision affect the financial position of STL? The purchase would reduce the firm’s working capital from HK$3.638 to HK$1.058, but STL should not be instantly put-off by this. A space purchase is not a liability; it is a venture that the company would speculate, a decrease in the firm’s working capital was spent to gain a company outlay. This asset’s value may increase or decrease depending on the rise and fall of the economy---which, unfortunately, is difficult to anticipate. This difficulty is what makes all these things complicated, making things more uncertain that leads to indecision on the company’s part. This lack of assertion is what keeps small and medium enterprises to buy a space, and STL is a small enterprise. It would take more than courage for a company to win over an anxiety of purchasing; it requires study and research on its probable results. This process entails several details that need analysis, investigation and a thorough examination. Should the company decide to purchase an office space, it would be resulting to an added investment but STL, being a small trading enterprise, does not have the luxury to spend much on another investment nor to commit a financial mistake. The purchase might bring about financial struggles, a need to cut off several costs which could be quite arduous, given the fact that some operating expenses are almost not possible to drop off. The decision to invest on its own office space will most likely cause financial constriction, and would therefore need brilliant ideas and plans to contradict or prevent the apparent destructive results. It would be best to make a list of the present company expenditures, inspect and assess on which among the listed expenses could a cost cutting plans be applied. The list may even result to a surprising fact that some of these could actually be reduced, it just calls for proper techniques and accurate approach. Realization and anticipation of this will absolutely aid the STL to be more precise, cautious and guarded and may preclude the company from going through serious financial breakdown. 4. Would you recommend that Jonathan Young buy or lease an office? Why and why not? The idea of buying an office space sounds extremely appealing but could really be financially draining. Several factors---including first-hand experiences of Jonathan Young’s friends, who, undeniably, did not take significant issues for granted---may make STL be besieged and find purchasing a tricky and risky step. This, most likely, would persuade Jonathan Young against buying one. Had STL been a larger company, it would have been easier to decide to purchase, but then, from that very same viewpoint, STL may still opt to buy its own space, taking the risk of financial intricacy for possible future expansion. Most businessmen seek the advice of colleagues, hearing out what these experienced people have to say based on their professional experiences. Often times, these keep them from seeing the best side: the significance of awareness of its negative results. It is therefore, not sensible to pay attention to things that are discouraging and disappointing for it may make you lose conviction, especially in times of difficulty, hence, it would be wise to know these significant factors, for most of these may be experienced by the company, but to use these as a lead, not as a reason to renounce. Some fail to note that recognition of the unhelpful factors alone may play a major role on survival. The fact that Jonathan Young knows too well the risk and the consequences, its core and probable effects may help SQL subsist the financial battle that is believed to be brought about by the purchase. Intelligent approach could then be planned ---anticipating worst scenarios---other options should then be formulated. Risk is a part of every business and this is exactly what makes successful people, successful. Risk, when teamed with clear-cut and skillful alternatives may define success. Foolish are those who see failures on mishaps, for these missteps, even those committed by Jonathan Young’s friends and colleagues could be an excellent example to come up with a exceptional approach on preventions. The idea of buying STL’s own office space may seem intimidating knowing the fact that it will trim down the company’s working capital to HK$1.058. This may be particularly strenuous, but there will always be ways to come up with options and means. A ten percent increase of HK$970,000 would be HK$1,067,000/year and like purchasing, this amount is also going to dwindle the company’s working asset, maybe not as drastic, but gradually, it definitely will result to the same effect for renting would continuously be a company liability while purchasing would be a form of investing. Had the rent been lower, STL, being a small enterprise, would be better off lease its office space, but the rent is basically as financially draining as purchasing, and this is what makes buying its own office space more practical. True, having its own office space may require additional taxes and may carry out several issues, both financial and legal, but willingness to go through this, plus awareness of its factors, beneficial and critical; may one day give financial stability to STL. This is not as simple as it seems, as discussed earlier, several factors need to be focused on---techniques have to be researched and well-planned---and even these is not a hundred percent guarantee, but then, a brilliant mind can always come up with several means. When one has the desire to come out triumphant, none would be considered as difficult. Noting the fact that renting costs are almost as much as the purchasing price, I strongly believe that it would be clever for STL to purchase its own space. Success comes to those who work for it, to those who are willing to take the risk. STL may one day find itself free from financial burden; not having to worry about its lease, for when success pairs with hard work and patience, it will bring about triumph. True, it will not be easy, the company will need to experience financial crisis, cost cutting and other constraints, but that is exactly what the challenge is. "One of the commonest mistakes and one of the costliest is thinking that success is due to some genius, some magic — something or other which we do not possess. Success is generally due to holding on, and failure to letting go. You decide to learn a language, study music, take a course of reading, train yourself physically. Will it be success or failure? It depends upon how much pluck and perseverance that word “decide” contains. The decision that nothing can overrule, the grip that nothing can detach will bring success. Remember the Chinese proverb, “With time and patience, the mulberry leaf becomes satin." (Babcock, Maltbie D). Works Cited Babcock, Maltbie D. Quotes for Success. 15 Apr 2008 < http://www.motivatingquotes.com/success.htm>. Read More