Question

1. Cherry hill Inc.’s balance sheet is shown below:

Assets	US$	liabilities and equity	US$
Assets	50000	Equity	50000
Total	50000	Total	50000

Cherry hill wishes to acquire equipment worth US$20,000. It can either buy
it by borrowing the required amount at a 10% rate of interest or it can
take it on lease for a period of 5 years. If it leases it, the lease rental would
be US$5276 per year. Assume taxes are absent.
Show the balance sheet of Cherry hill Inc. if:
(a) It finances the equipment with debt
(b) It leases the equipment as an operating lease
(c) It leases the equipment as a financial lease (hint: find the present
value of lease rentals at a discount rate of 10%)

Answer 1

(a)	It finances the equipment with debt
	Assets	US$	liabilities and equity	US$
	Assets	70000	Equity	50000
			Liability - Loan	20000
	Total	70000	Total	70000
(b)	It leases the equipment as an operating lease
	Assets	US$	liabilities and equity	US$
	Assets	50000	Equity	50000
	Total	50000	Total	50000
	** Lease payment should be recognized as an expense in the profit and loss account on straight line basis over the lease term.
(c)	It leases the equipment as a financial lease
	Assets	US$	liabilities and equity	US$
	Assets	69,999.73	Equity	50000
			Liability- Lease Liability	19,999.73
	Total	69,999.73	Total	69,999.73
	Computation of Present Value of Lease Rentals
	Year	Lease Rent (A)	Discount rate at 10% (B)	Present Value (A*B)
	1	5276	0.9091	4,796.41
	2	5276	0.8264	4,360.09
	3	5276	0.7513	3,963.86
	4	5276	0.683	3,603.51
	5	5276	0.6209	3,275.87
	Total	26380		19,999.73
	** In case of finance lease Leased asset as well as Liability for lease should be recognized at the lower of :- 1)Fair value of the leased asset at the inception of lease or 2) present value of minimum lease payment, which ever is lower Here :- $19,999.73 < $20000