Question

In: Accounting

Ivanhoe Leasing Company (lessor) agrees to lease equipment to Sarasota Construction (Lessee) on January 1, 2017....

Ivanhoe Leasing Company (lessor) agrees to lease equipment to Sarasota Construction (Lessee) on January 1, 2017. The following information relates to the lease agreement.

(a) the term of the lease is 7 years with no renewal option, and the machinery has an estimated economic life of 9 years.

(b) the cost of the machinery is $653,420 , and the fair value of the asset on January 1, 2017, is $887,406.

(c) At the end of the lease term, the asset reverts to the lessor and has an unguaranteed residual value of $100,000. Sarasota incurs initial direct costs of $1,400 and amortizes all of its leased equipment on a straight line basis. In addition, Sarasota agrees to pay the fixed annual insurance on the equipment of $3,000 to Ivanhoe at the same time as the rental payments.

(d) the lease agreement requires equal annual rental payments, beginning on January 1, 2017.

(e) the collectibility of the lease payments is probable.

(f) Ivanhoe desires an 10% rate of return on its investments. Sarasota's incremental borrowing rate is 12%, and the lessor's implicit rate is unknown to Sarasota.

calculate the amount of the annual rental payment required by Lessor including the fixed insurance payment (hint: calculate annual rental payment without insurance first)

Solutions

Expert Solution

Annual rental payment is calculated bu lessor based on the 10%
Payment Year PV factor @ 10%
1 0                    1.00000
2 1                    0.90909
3 2                    0.82645
4 3                    0.75131
5 4                    0.68301
6 5                    0.62092
7 6                    0.56447
Total                    5.35526
Fair value of the asset on January 1, 2017 $                887,406
Divided by: PV factor of annuity @10% for 7 Years                    5.35526
Annual rental payment without insurance $                165,707
Add: insurance payments $                    3,000
Annual rental payment including insurance payment $                168,707

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