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.

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.