The Deluxe Corporation has just signed a 144-month lease on an asset with a 17-y

Question

The Deluxe Corporation has just signed a 144-month lease on an asset with a 17-year life. The minimum lease payments are $3,300 per month ($39,600 per year) and are to be discounted back to the present at a 11 percent annual discount rate. The estimated fair value of the property is $265,000. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the lease is set up as an annual lease.

Calculate the lease period as a percentage to the estimated life of the leased property. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Calculate the present value of lease payments as a percentage to the fair value of the property. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

The Deluxe Corporation has just signed a 144-month lease on an asset with a 17-year life. The minimum lease payments are $3,300 per month ($39,600 per year) and are to be discounted back to the present at a 11 percent annual discount rate. The estimated fair value of the property is $265,000. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the lease is set up as an annual lease.

Explanation / Answer

a.

Lease period percentage = 12/ 17 x 100 = 70.59%

b.

Present value of minimum lease payments = $ 39,600 x FVIFA 11%, 12 years = $ 39,600 x 6.4924 = $ 257,099

Present value of lease payment percentage = 257,099 / 265,000 = 97.02 %

c. The lease should be recorded as a capital lease.

Though the lease period covers only 70.59% of the estimated life of the leased asset ( minimum 75% required), the present value of lease payment percentage, at 97.02%, is higher than the minimum mandated 90% of the fair value of the property. Hence, it should be treated as a capital lease.

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