Let's break down the problem and calculate the **return** (Net Operating Income, After-Tax Cash Flow, etc.) for **leasing** the office building. --- ### **Step 1: Calculate Incremental Revenues and Expenses** #### **Incremental Revenue** - **Annual Sales:** $2,500,000 #### **Cost of Goods Sold (COGS)** - **COGS = 40% of Sales** - COGS = 0.40 × $2,500,000 = **$1,000,000** #### **Corporate Overhead** - **Increase in Overhead (not including office space):** $307,500 #### **Lease Payment** - **Annual Lease Payment:** $450,000 #### **Real Estate Operating Expenses** - **Paid by corporation (absolute net):** 50% of lease = 0.5 × $450,000 = **$225,000** #### **Other Upfront Costs** - **Office furniture/equipment/upfront:** $2,500,000 (we will assume this is depreciated over its useful life, but unless a period is given, we may consider as immediate outflow for simplicity) --- ### **Step 2: Calculate Annual Pre-Tax Cash Flow** #### **Operating Income (EBIT, before lease and office cost)** \[ \text{Sales} - \text{COGS} - \text{Overhead} \] \[ \$2,500,000 - \$1,000,000 - \$307,500 = \$1,192,500 \] #### **Subtract Lease and Operating Expenses** \[ \text{Operating Income} - \text{Lease Payment} - \text{Operating Expenses} \] \[ \$1,192,500 - \$450,000 - \$225,000 = \$517,500 \] --- ### **Step 3: Calculate Taxes** #### **Taxable Income** - All lease and overhead expenses are tax deductible. #### **Tax Calculation** \[ \text{Tax} = 21\% \times \$517,500 = \$108,675 \] #### **Net Income After Tax** \[ \text{Net Income} = \$517,500 - \$108,675 = \$408,825 \] --- ### **Step 4: Upfront Investment** - **Upfront investment in furniture/equipment:** $2,500,000 (assume paid at the start, not depreciated for this calculation unless more info is given) --- ### **Step 5: Return Calculation** There are two ways to look at "return": - **Annual return on upfront investment** (simple payback) - **NPV or IRR over 15 years** (if you want a true investment return, we'd need to model cash flows over 15 years, including the upfront cost, and possibly recover any residual value of furniture/equipment). #### **A. Simple annual return (first-year cash flow / upfront investment):** \[ \text{Annual after-tax cash flow} = \$408,825 \] \[ \text{Upfront investment} = \$2,500,000 \] \[ \text{Return} = \frac{\$408,825}{\$2,500,000} = 0.1635 = 16.4\% \] #### **B. 15-Year Cumulative Cash Flow (ignoring time value)** \[ \$408,825 \times 15 = \$6,132,375 \] \[ \text{Total return over 15 years (not discounted)} = \$6,132,375 - \$2,500,000 = \$3,632,375 \] But this ignores the time value of money and possible salvage value. #### **C. NPV over 15 years (if a discount rate is given)** If you want NPV, you'd discount the $408,825 over 15 years and subtract $2.5M. (Let me know if you want this, and specify a required rate of return.) --- ## **Summary Table** | Item | Amount | |----------------------------|---------------| | Annual Revenue | $2,500,000 | | COGS (40%) | $1,000,000 | | Corporate Overhead | $307,500 | | Lease Payment | $450,000 | | Real Estate Op. Expenses | $225,000 | | **Pre-tax Income** | $517,500 | | Taxes (21%) | $108,675 | | **Net Income (after-tax)** | $408,825 | | Upfront Investment | $2,500,000 | | **Simple Return** | **16.4%** | --- ## **Conclusion** **The annual after-tax return from opening the office building under the assumption that it is leased is approximately $408,825 per year, or a 16.4% return on the $2,500,000 initial investment in furniture and equipment.** If you want a more detailed NPV or IRR analysis (over 15 years), please specify a discount rate. If you want to include salvage values or depreciation on the furniture/equipment, let me know.

Now, let's walk through what this analysis really means. Essentially, we're looking at what kind of return the company can expect if it proceeds with leasing the office building instead of buying it outright. To start, the company expects to generate an additional $2.5 million in annual sales from opening the new office. From this, we deduct the cost of goods sold, which is 40% of sales—so that's $1 million annually—leaving us with a gross profit of about $1.5 million before considering other expenses. So, the next step involves looking at the incremental operating expenses. The corporate overhead is estimated to increase by $307,500, and the lease payment for the office building would be $450,000 per year. Additionally, because the lease is an absolute net lease, the company will pay real estate operating expenses, which are roughly 50% of the lease payment, amounting to $225,000 annually. When we subtract these expenses from the gross profit, we're left with an operating income of approximately $517,500. Now, considering the company's tax rate of 21%, we calculate taxes on this income, which come to about $108,675. After taxes, the company would net roughly $408,825 each year from this leasing arrangement. This figure represents the company's annual after-tax cash flow attributable to the new office under the lease scenario. Therefore, if we compare this annual net income to the initial upfront investment—mainly the furniture, equipment, and other setup costs totaling $2.5 million—we find that the company’s return on this investment is approximately 16.4%. In other words, each year, the company earns about 16% of its initial investment back after taxes, just from the operating cash flow generated by the new office. So, to sum up, the key takeaway is that leasing the office building yields an annual after-tax return of around 16.4% based on these estimates. Of course, this is a simplified view that doesn't fully account for the time value of money or potential residual values at the end of the lease term, but it provides a solid starting point for understanding the investment's profitability. If you want to dig deeper into the long-term financial implications, like calculating the net present value or internal rate of return over the 15-year lease period, we can certainly do that too.