Your firm is considering leasing a $51,000 copier. The copier has an estimated e

Question

Your firm is considering leasing a

$51,000

copier. The copier has an estimated economic life of eight years. Suppose the appropriate discount rate is

8.9%

APR with monthly compounding.

Classify each lease below as a capital lease or operating? lease, and explain? why:

a. A? four-year fair market value lease with payments of

$1,140

per month.

b. A? six-year fair market value lease with payments of

$790

per month.

c. A? five-year fair market value lease with payments of

$925

per month.

d. A? five-year fair market value lease with payments of

$995

per month and an option to cancel after three years with a??

$8,500

cancellation penalty.

Explanation / Answer

For lease to be classified as Capital Lease, one of four conditions must be met::

- A transfer of ownership of the asset at the end of the term

- An option to purchase the asset at a discounted price at the end of the term

- The term of the lease is >75% of the useful life of the asset

- The Present Value (PV) of the lease payments is >90% of the asset’s fair market value

a. Fair Market Value = $1,140 monthly, APR (Annual Percentage Rate) = 8.9%, APR Monthly = 8.9% / 12 0.74%, Time = 4 years = 48 months.

ExcelFormula: = PV (Rate, nper, PMT,type)

Rate = 0.74%, nper = 48, pmt = 1,140

Present Value = $ 45898.18 = 90% of value of Copier ((45898.18 /51,000) =90%

The PV is not greater than copier value.

The lease will be classifiesd as operating lease.

b. Same as above,

pmt = $790, Time = nper = 6*12 = 72, ,rate = 0.74%

PV =$ 43, 947.6 = 86.17% of value.

Term of the lease is 75% of the economic life (6/8)*100 = 75%

Since it is not greater than 75% it will be classified as operating lease.

c. pmt = $925, Time = nper = 5*12 = 60, ,rate = 0.74%

PV = $44, 664.72

PV % of cpier value = 87.58%, Lease % of Economic Life = 62.5%

The will be classified as operating lease.

d. pmt = $995, Time = nper = 5*12 = 60, ,rate = 0.74%

PV = $48,044.76 = 94.21% of Copier Value

Lease wil be classified as Capital Lease.

e. PV of lease payments for 3 years = $31,355.41 (pmt = $995, nper = 36, rate =0.74)

PV of cancelation if cancelled = 21,554.4

Total PV of pmt = 31,355.41 + 21,554.4 = $52,889.8 = 103 % of Copier value.

Lease will be classified as Capital Lease

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

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