Red Leasing Company agrees to lease machinery to Fisher Corporation on January 1

Question

Red Leasing Company agrees to lease machinery to Fisher Corporation on January 1, 2017. The following information relates to the lease agreement. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. The cost of the machinery is $473,000, and the fair value of the asset on January 1, 2017, is $746,000. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $91,000. Fisher depreciates all of its equipment on a straight-line basis. The lease agreement requires equal annual rental payments, beginning on January 1, 2017. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. Red desires a 10% rate of return on its investments. Fisher’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. (Assume the accounting period ends on December 31.) 1. Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) 2. Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Red Leasing Company agrees to lease machinery to Fisher Corporation on January 1, 2017. The following information relates to the lease agreement. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. The cost of the machinery is $473,000, and the fair value of the asset on January 1, 2017, is $746,000. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $91,000. Fisher depreciates all of its equipment on a straight-line basis. The lease agreement requires equal annual rental payments, beginning on January 1, 2017. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. Red desires a 10% rate of return on its investments. Fisher’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. (Assume the accounting period ends on December 31.) 1. Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) 2. Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.)

Explanation / Answer

Question. Red Leasing Company agrees to lease machinery to Fisher Corporation on January 1, 2017. The following information relates to the lease agreement The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years. The cost of the machinery is $473,000, and the fair value of the asset on January 1, 2017, is $746,000. At the end of the lease term, the asset reverts to the lessor and has a guaranteed residual value of $91,000. Fisher depreciates all of its equipment on a straight-line basis. The lease agreement requires equal annual rental payments, beginning on January 1, 2017. The collectibility of the lease payments is reasonably predictable, and there are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. Red desires a 10% rate of return on its investments. Fisher’s incremental borrowing rate is 11%, and the lessor’s implicit rate is unknown. (Assume the accounting period ends on December 31.) Q1. Calculate the amount of the annual rental payment required. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Solution1. Fair Value of the Asset (recovery amount)= 7,46,000 Less: Present value of guaranteed residual = FV/(1+r)^n = 91,000/(1+0.1)^7 = -46697.388759 PV annually = 6,99,302.61124 Amount of the annual rental payments or PV of annuity due = PMT* ((1-((1+r)^-n)/r))*(1+r) = PMT*((1-((1+0.1)^-7))/0.1)*(1+0.1) PMT*5.35526 Payment = 6,99,302.61124/5.35526 = $1,30,582 (answer) Q2 Compute the present value of the minimum lease payments. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 58,971.) Sol2: Present value of minimum lease payments: (use n=7, i=11%) PV of minimum rental payments = Annuity Payment* ((1-((1+r)^-n)/r))*(1+r) = 1,30,582*((1-((1+0.11)^-7))/0.11)*(1+0.11) 6,83,014.09402 Guaranteed Residual Value = FV/(1+r)^n = 91,000/(1+0.11)^7 =      43,830.91539          Present value of minimum lease payments = $7,26,845 (answer)

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