Lease Payments Montevallo Corporation leased equipment from Folio Company. The lease term is 10 years, requires...

Lease Payments

Montevallo Corporation leased equipment from Folio Company. The lease term is 10 years, requires payments of $25,000 at the end of each year, and contains a bargain purchase option. At the end of the lease, Montevallo has an option to pay $4,000 (which is significantly less than the estimated fair value at that time) to purchase the equipment. The equipment has a fair value at the inception of the lease of $175,000 and an estimated useful life of 20 years. The lease agreement stipulates that Folio receive a rate of return of 8% each year. Montevallo’s incremental borrowing rate is 10% each year.

Assume that there is no bargain purchase option and that Montevallo guarantees the $20,000 estimated residual value at the end of the 10-year lease. Montevallo estimates that it is probable that it will have to pay $15,000 cash due to the residual value guarantee.

Calculate the present value of the lease payments. For interim computations, carry amounts out to two decimal places. Round your final answer to the nearest dollar.

Solutions

Expert Solution

for Present value of lease payment below data will be used

lease payment =$ 25000

Period = 10 year

Incremental borrowing rate= 10% pa

residual value payment= $15000

Present value = $159,397 (including present value of lease payment and residual value payment) as per below table and formula given.

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10	Total
(number of year)	1	2	3	4	5	6	7	8	9	10
lease payments	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$250,000.000
residual value payment										$15,000.000	$15,000.000
Net Cash flow CF=NP+D	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$25,000.000	$40,000.000	$265,000.000
Cost of Capital	10%	10%	10%	10%	10%	10%	10%	10%	10%	10%
Present value of cash flows	$22,727.273	$20,661.157	$18,782.870	$17,075.336	$15,523.033	$14,111.848	$12,828.953	$11,662.685	$10,602.440	$15,421.732	$159,397.327
(formula)	CF/(1+.13)^1	CF/(1+.13)^2	CF/(1+.13)^3	CF/(1+.13)^4	CF/(1+.13)^5	CF/(1+.13)^6	CF/(1+.13)^7	CF/(1+.13)^8	CF/(1+.13)^9	CF/(1+.13)^10
Total Cash inflow	$265,000.000
Present value of cash flows	$159,397.327

PV formula	NPV(rate,range of cash flow)

jeff jeffy answered 1 year ago

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