Question

Crane Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Cheyenne Medical Center for a period of 10 years. The normal selling price of the machine is $495,371, and its guaranteed residual value at the end of the non-cancelable lease term is estimated to be $14,500. The hospital will pay rents of $60,000 at the beginning of each year. Crane incurred costs of $273,000 in manufacturing the machine and $13,000 in legal fees directly related to the signing of the lease. Crane has determined that the collectibility of the lease payments is probable and that the implicit interest rate is 5%. Cheyenne Medical Center has an incremental borrowing rate of 5% and an expected residual value at the end of the lease of $10,000.

Discuss the nature of this lease in relation to the lessee.

The nature of this lease in relation to the lessee is ?

Compute the amount of the initial lease liability. (Round present value factor calculations to 5 decimal places, e.g. 1.25124 and the final answer to 0 decimal places e.g. 5,275.)

Initial Lease Liability

Answer 1

a.) The nature of this lease in relation to the Lessee is Capital lease ,because the present value of lease payment of $ 495,371 which equal to fair value of machine of $ 495,371 statisfying the condition of present value of the lease payments is greater than or equal to 90% of the asset’s fair market value. Further the lease term is 83.33% ( 10/12 ) of life of machine which satisfy the condition of lease term greater than or equal to 75% of useful life of asset.

b.)

Initial Lease liability

$ 495,371

Working :
Year	Lease Payment	PV Factor @5%	Present Value $
1	60,000	1	60,000
2	60,000	0.95238	57,143
3	60,000	0.90703	54,422
4	60,000	0.86384	51,830
5	60,000	0.82270	49,362
6	60,000	0.78353	47,012
7	60,000	0.74622	44,773
8	60,000	0.71068	42,641
9	60,000	0.67684	40,610
10	60,000	0.64461	38,677
10 End	14,500	0.61391	8,902
Total	614,500		495,371