Calculate the amount of the annual rental payment. On January 1, 2014, Bensen Co

Question

Calculate the amount of the annual rental payment.

On January 1, 2014, Bensen Company leased equipment to Flynn Corporation. The following information pertains to this lease.
1. The term of the noncancelable lease is 6 years, with no renewal option. The equipment reverts to the lessor at the termination of the lease. 2. Equal rental payments are due on January 1 of each year, beginning in 2014. 3. The fair value of the equipment on January 1, 2014, is $197,500, and its cost is $158,000. 4. The equipment has an economic life of 8 years, with an unguaranteed residual value of $10,580. Flynn depreciates all of its equipment on a straight-line basis. 5. Bensen set the annual rental to ensure an 10% rate of return. Flynn’s incremental borrowing rate is 11%, and the implicit rate of the lessor is unknown. 6. Collectibility of lease payments is reasonably predictable, and no important uncertainties surround the amount of costs yet to be incurred by the lessor.
(Both the lessor and the lessee’s accounting period ends on December 31.)

Explanation / Answer

Fair Market Value = 197500

Residual Value = 10580

Lessor's required rate = 10%

Annual lease rental = (Fair Market value - Present value of residual value)/PVAD(10%,6years)

Where PVAD(10%,6 years) is equal to Present value factor for annuity due at 10% for 6 years at begining of period. = 4.79079

Presnt value factor for residual value at 10% ,6 years = 0.56447

Therefore Annual lease payment = (197500-10580*0.56447)/4.79079 = $ 39978.36

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