Multiple Choice Question 70 Wildhorse, Inc. leased equipment from Tower Company

Question

Multiple Choice Question 70

Wildhorse, Inc. leased equipment from Tower Company under a 4-year lease requiring equal annual payments of $434152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4 year useful life and no salvage value. Wildhorse, Inc.’s incremental borrowing rate is 9% and the rate implicit in the lease (which is known by Wildhorse, Inc.) is 7%. Assuming that this lease is properly classified as a capital lease, what is the amount of principal reduction recorded when the second lease payment is made in Year 2?

PV Annuity Due

PV Ordinary Annuity

7%, 4 periods

3.62432

3.38721

9%, 4 periods

3.53129

3.23972

$331212

$293616

$354397

$434152

PV Annuity Due

PV Ordinary Annuity

7%, 4 periods

3.62432

3.38721

9%, 4 periods

3.53129

3.23972

Explanation / Answer

Solution:

Present value of minimum lease payment = Annual lease payment * Cumulative PV factor of annuity due for 4 periods at 7%

= $434,152 * 3.62432 = $1,573,506

First payment = $434,152

Principal outstanding after first lease payment = $1,573,506 - $434,152 = $1,139,354

Second lease payment at beginning of 2nd year = $434,152

Interest component in lease payment = $1,139,354 * 7% = $79,755

Amount of principal reduction to be recorded when the second lease payment is made in Year 2 = $434,152 - $79,755

= $354,397

Hence 3rd option is correct.

Related Questions

Navigate

• Browse (All)
• Browse M
• Subjects

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