Question

Russell Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Edge Medical Center for a period of 10 years. The normal selling price of the machine is $495,678, and its guaranteed residual value at the end of the non-cancelable lease term is estimated to be $15,000. The hospital will pay rents of $60,000 at the beginning of each year. Russell incurred costs of $300,000 in manufacturing the machine and $14,000 in legal fees directly related to the signing of the lease. Russell has determined that the collectibility of the lease payments is probable and that the implicit interest rate is 5%.

Required:

1.     Please show the calculation(s)/discussion of the test you use to answer the following questions:

a.     What type of lease is this for the lessor?

Answer 1

year	cash flows	PVF@5%	Discounted Cash flows
0	60,000.00	1	60,000.00
1	60,000.00	0.9259	55,554.00
2	60,000.00	0.8573	51,438.00
3	60,000.00	0.7938	47,628.00
4	60,000.00	0.735	44,100.00
5	60,000.00	0.6806	40,836.00
6	60,000.00	0.6302	37,812.00
7	60,000.00	0.5835	35,010.00
8	60,000.00	0.5403	32,418.00
9	60,000.00	0.5002	30,012.00
9	15,000.00	0.5002	7,503.00
Discounted Lease payments			442,311.00
Normal Selling Price or Fair Value of an asset is $ 495678
Minimum lease payments are $ 442311
The Present valure of lease payments that is $442311 equals 89.23%(around 90%) of the fair market value of the asset that is $495678.00
Also lease covers major part of the economic life of the asset that is 10years out of 12 years which is 83.33% which is more than 75%
therefore the lease is a FINANCE LEASE.