In 2013, McDowell Enterprises negotiated and closed a long-term lease contract f

Question

In 2013, McDowell Enterprises negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On January 1, 2014, McDowell took possession of the leased property. The 20-year lease is effective for the period January 1, 2014, through December 31, 2033. Advance rental payments of $816,200 are payable to the lessor (owner of facilities) on January 1 of each of the first 10 years of the lease term. Advance payments of $408,600 are due on January 1 for each of the last 10 years of the lease term. McDowell has an option to purchase all the leased facilities for $1 on December 31, 2033. At the time the lease was negotiated, the fair value of the truck terminals and freight storage facilities was approximately $7,220,800. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest.

Last year the company exchanged a piece of land for a non-interest-bearing note. The note is to be paid at the rate of $14,820 per year for 9 years, beginning one year from the date of disposal of the land. An appropriate rate of interest for the note was 12%. At the time the land was originally purchased, it cost $90,780.

What is the fair value of the note?

Explanation / Answer

Fair value of Note:

Assets exchanged:    Land

Cost of land         : 90,870

Return on Note per year:   14,820

Appropriate interest rate :   12 %

Period of return               : 9 year

First payment. One year after exchange

P.V factor for 9 year from period T1 = 5.995225

Fair value of Land : 88,850   (14,820 * 5.995225)

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