Intermediate Accounting: Time Value of Money Concepts Southwest Airlines provide

Question

Intermediate Accounting: Time Value of Money Concepts

Southwest Airlines provides scheduled air transportation services in the United States. Like many airlines, Southwest leases many of its planes from Boeing Company. In its long-term debt disclosure note included in the financial statements for the year ended December 31, 2013, the company listed $56 million in lease obligations. The existing leases had an approximate eight-year remaining life and future lease payments average approximately $8 million per year.

Determine the effective interest rate the company used to determine the lease liability assuming that lease payments are made at the end of each fiscal year.

Explanation / Answer

Take Two discount rates Say 2 % and 10%. [ One rate at which P.V. of future lease payment is greater than the lease obligations of $ 56 million and another rate at which P.V. of future lease payment is less than the lease obligations of $ 56 million.]

At 2 %

Cumulative P.V. factor for 8 Years @ 2% = 7.3255

P.V. of future lease payment at the end of each year for 8 years = 8 * 7.3255 = $ 58.604 Million

At 10 %

Cumulative P.V. factor for 8 Years @ 10% = 5.3349

P.V. of future lease payment at the end of each year for 8 years = 8 * 5.3349 = $ 42.6792 Million

Effective interest rate (by interpolation) = 2 + (58.604 - 56) * (10 - 2) / (58.604 - 42.6792)

   = 2 + 2.604 * 8 / 15.9248

= 2 + 20.832 / 15.9248

= 2 + 1.31 (approx)

= 3.31% (approx)

Conclusion:- The effective interest rate the company used to determine the lease liability assuming that lease payments are made at the end of each fiscal year will be 3.31%

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.