Finance and capital markets
Back of the envelope calculation of which office space to rent. Created by Sal Khan.
What I want to do in this video is kind of give a back of the envelope way for thinking about a conundrum that the Khan Academy is facing right now. And you could do a little bit more of a precise way with present valuing and all of that. But this will give you a pretty good sense of how to make this decision. So we're seriously looking at office space. I've changed these numbers to simplify things a little bit. But there's a nice office, and it's going for $2,000 per month. And then there's this dingy office. It's really too dingy. It's a converted nightclub and it's really too dingy to be a respectable place to work, but it's going for $1,000 a month. And I talked to a contractor. And once again, I'm simplifying these numbers. These numbers aren't the exact numbers, but it makes the math a little bit simpler. The contractor says it would cost us about $10,000 to get this dingy office to the condition of the nice office. And in either situation, we are thinking about a 24 month lease, so a two year lease. And the contractor said it would take one month of work to get the dingy office space up to speed. So the nice office space landlord he says, look, it'll be a 24 month lease. You could just occupy it. It's ready to go. The dingy office space, I talked him about this idea of us investing money in repairing it. He's like, OK, if you need to repair it-- he's kind not the easiest person to deal with-- he says, I'm going to charge you an extra month of rent. So even while I'm repairing it, I have to pay rent. So he'll say, I'm willing to do a 25 month contract, a 25 month lease with you. So you could still, once you repair it, you still get two years of service from the dingy office. So which one should I do? And I'll tell you my emotions, I want to do the nice one because I don't want to spend $10,000 and make this all nice and then two years later, the landlord could raise the rent. But let's just think about it rationally. Which one makes sense? And the easiest way to think about that is, what is the effective amount of rent, in a very back of the envelope way, that we're paying for the dingy office? So if you think about it over the entire lease, we're going to have 25 months. We're going to pay $1,000 per month. So it's going to be $25,000 plus $10,000 to repair it. So plus $10,000. I'll just write 10k like I did before. Plus 10k. And in terms of the useful life, because over here when we're saying per month, every month here is useful. So how many useful months are here? Well we're going to spend one month to repair it. We only get 24 useful months. So we only get 24 useful months. So if you view it this way, not doing any fancy present valuing, just back of the envelope, it is $35,000 over 24 months. And so let's get our calculator out. I guess it's not pure back of the envelope, but pretty close to pure back of the envelope. 35,000 divided by 24 is equal to 1,458. So this is equal to approximately $1,458 per month. So even though I don't want to invest in this property, and I'm only going to be able to use two years and this person's going to be able to raise the rent after that, it actually still makes a lot of sense. It still makes actually almost $500 a month of sense or more than $500 a month of sense in this kind of back of the envelope way to get the dingy office and repair it.