Question
In: Finance
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) |
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