Question

The Deluxe Corporation has just signed a 144-month lease on an asset with a 17-year life. The minimum lease payments are $2,200 per month ($26,400 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 $210,000. 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.

Should the lease be recorded as a capital lease or an operating lease.

Answer 1

a) Caluculation of lease period as a percentage to the estimated life of the leased property

given lease period is 144 months or 144/12 = 12 years

% of lease period = lease period / life of the asset

= 12 / 17

= 0.7059 or 70.59%

b) Calculation the present value of lease payments as a percentage to the fair value of the property.

given, annual lease rentals = $26,400, n(lease period) =12 years, r(interest rate) = 11%

PV of lease rentals = $26400*PVAF(11%,12)

= $26400*{(1-1/(1.11)^12) / 0.11} [ PVAF(r,n) = {(1-1/(1+r)^n) / r}, where r= interest rate, n= time period ]

= $26400 * {(1-1/3.498) / 0.11}

= $26400 * {(1-0.2859 / 0.11}

= $26400 * 6.492

= $1,71,389.37

PV of Lease Payments Percentage = $1,71,389.37/ $2,10,000 = 81.61%

c) Since the lease life is less than 75% & PV of lease payments is less than 90%, it is considred as a Operating lease, Any thing Above will be Finance lease or Capital Lease