BU Accounting Discussion

Part 4 – Making a Capital Budget Decision – 3 points

Missouri Jazz and Blues (MJB), a Kansas City-based organization for which you are the Chief Financial Officer, is considering purchasing a space to begin holding performances in a second location, on the other side of the state. An old theater in St. Louis is available for purchase. The following estimates have been provided to you:

Cost of renovating the theater: $14 million (assume this would be done immediately)

Annual operating cost: $3.5 million

Annual ticket sales: $5.5 million

The theater will need major renovation after ten years, and the residual value of the property at that time will be $50 million, considering real estate trends in the St. Louis area in recent years.

You believe that a 5% discount rate is appropriate, and have been furnished with the following additional information using that rate:

Present Value (10 years, rounded to the nearest $000):

Operating Costs: $27,026,000

Ticket Sales: $42,470,000

(note that, for simplicity, the PV was calculated as a year-end annuity each year)

Residual Value: $30,696,000

(note that, for simplicity, the discounting is done on an annual, or ten-period, basis)

Taking into account only this financial information—and not, for example, any donations MJB might be able to raise from patrons interested in having seats, the lobby, or even the entire renovated theater building named after themselves or members of their family—what is the maximum amount you’d be willing to pay for the theater at this time? Please explain your answer with an appropriate calculation.