Orange Leasing Company signs an agreement on January 1, 2015, to lease equipment

Question

Orange Leasing Company signs an agreement on January 1, 2015, to lease equipment to ABC Company. The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 8 years. The cost of the asset to the lessor is $400,000. The fair value of the asset at January 1, 2015, is $500,000. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $80,000, none of which is guaranteed. The agreement requires equal annual rental payments, beginning on January 1, 2015. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor. Assume the lessor desires a 10% rate of return on its investment, the amount of the annual rental payment should be:

$70,000

$84,959

$89,211

$94,941

Explanation / Answer

Answer:

Correct answer is $94,941.

Present value of all lease payments + Present value of residual amount = Fair value of assets today

Lease Payment * 1- (1+interest)^-number of period / interest + 80,000/ (1.1)^6 = $ 500,000

Lease Payment * 1- (1+.1)^-5 / .1 + Lease Payment (on 1st Jan 2015) + 80,000 / (1.1)^6 = $500,000

Lease Payment = $ 94,941

Related Questions

Navigate

• Browse (All)
• Browse O
• Subjects

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