Brief Exercise 21A-1 (Essay) Callaway Golf Co. leases telecommunications equipme

Question

Brief Exercise 21A-1 (Essay) Callaway Golf Co. leases telecommunications equipment from Photon Company. Assume the following data for equipment leased from Photon Company. The lease term is 5 years and requires equal rental payments of $31,000 at the beginning of each year. The equipment has a fair value at the commencement of the lease of $150,000, an estimated useful life of 8 years, and a guaranteed residual value at the end of the lease of $15,500. Photon set the annual rental to earn a rate of return of 6%, and this fact is known to Callaway. The lease does not transfer title or contain a bargain purchase option, and is not a specialized asset. How should Callaway classify this lease? Click if you would like to Show Work for this question: Open Show Work

Explanation / Answer

The lease is classified as a capital lease .

Present value of future payment =[PVA 6%,5*Annual payment ]+[PVF 6%,5*Residual value]

=[4.46511*31000] +[0.74726*15500]

= 138418.27+ 11582.53

= 150000

since the present value of minimum lease payment is equal or more than 90% fair market value ,the lease is a capital lease

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