PV Annuity Due PV Ordinary Annuity 3.57710 3.31213 3.53129 3.23972 Cullumber, In

Question

PV Annuity Due

PV Ordinary Annuity

3.57710

3.31213

3.53129

3.23972

Cullumber, Inc. leased equipment from Tower Company under a 4-year lease requiring equal annual payments of $354152, 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. Cullumber, Inc.’s incremental borrowing rate is 9% and the rate implicit in the lease (which is known by Cullumber, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of interest expense recorded by Cullumber, Inc. in the first year of the asset’s life?

PV Annuity Due

PV Ordinary Annuity

8%, 4 periods

3.57710

3.31213

9%, 4 periods

3.53129

3.23972

$31874 $73015 $93840 $0

Explanation / Answer

Calculation of Present value of all the lease payment four year using the rate implicit in the lease

=  Annual lease payments * PV Annuity 8%, 4 periods = $354,152 * 3.57710 = $1,266,837

Interest expense recorded by Cullumber, Inc. in the first year of the asset’s life :

(Present value of all the lease payment - Actual annual payment) * rate implicit in the lease

= ($1,266,837 - $354,152) * 8 % = $73,015 (option b)

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