Question

In: Accounting

O’Brien, Inc. needs a stamping machine for their factory so they can better meet customers’ requirements....

  1. O’Brien, Inc. needs a stamping machine for their factory so they can better meet customers’ requirements. After investigating numerous alternatives they have the following alternatives:
  2. Purchase Machine A for $120,000.
  3. Lease Machine B, a similar machine, for 7 years (8 year EUL) for $20,000 at the beginning of each year. There is no transfer of ownership or bargain purchase option. There is no salvage value at the end of the lease term. O’Brien’s incremental borrowing rate is 9%.
  4. Use Excel to prepare a lease amortization schedule and a depreciation schedule for the term of the lease. Prepare journal entries for the inception of the lease and the first three lease payments and first three depreciation entries. Should O’Brien purchase Machine A or lease Machine B? Why?

Solutions

Expert Solution

Present value of the future lease payments = Lease payments * Present value of annuity due ( 9%, 7years) = 5.48592 * 20,000 = 109718.4

Year Lease payments Interest on lease liability
[PV of lease *9%]		 Reduction of lease liability
[Lease - Interest]		 Lease liability
[ Pv of previous year - Principal]
Inception 109718.4
1 20,000 0 20,000 89,718
2 20,000 8074.656 11,925 77,793
3 20,000 7001.37504 12,999 64,794
4 20,000 5831.498794 14,169 50,626
5 20,000 4556.333685 15,444 35,182
6 20,000 3166.403717 16,834 18,349
7 20,000 1651.380051 18,349 0
Date Account Titles Debit Credit
Year 1 Leased equipment 109718
Obligation under capital lease 109718
Year 1 Obligation under capital lease 20,000
Cash 20,000
Year 1 Depreciation expense
[109718/7]		 15674
Accumulated depreciation - capital leases 15674
Year 2 Obligation under capital lease 11,925
Interest payable 8075
Cash 20,000
Year 2 Depreciation expense
[109718/7]		 15674
Accumulated depreciation - capital leases 15674
Year 3 Obligation under capital lease 12,999
Interest payable 7001
Cash 20,000
Year 3 Depreciation expense
[109718/7]		 15674
Accumulated depreciation - capital leases 15674

The company should lease the machine since the present worth of cash outflows is lesser as compared to purchasing the machine.

ekkarill92 answered 2 years ago
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