Question

For each of the three independent situations below determine the amount of the annual lease payments. Each describes a finance lease in which annual lease payments are payable at the beginning of each year. Each lease agreement contains an option that permits the lessee to acquire the leased asset at an option price that is sufficiently lower than the expected fair value that the exercise of the option appears reasonably certain. (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

	Situation
	1			2			3
Lease term (years)		5			5			4
Lessor's rate of return		12	%		9	%		7	%
Fair value of leased asset	$	66,000		$	423,000		$	188,000
Lessor's cost of leased asset	$	53,000		$	423,000		$	148,000
Purchase option:
Exercise price	$	13,000		$	53,000		$	25,000
Exercisable at end of year:		5			5			3
Reasonably certain?		yes			no			yes

Determine the annual lease payments for each situation

Answer 1

Formula: Annual lease payments = Amount to be recovered through periodic lease payments / PV factor of annuity due at given interest rate

Amount to be recovered through periodic lease payments = Fair value of leased asset – Present value of purchase option

Situation 1:

Fair value of leased asset = $66,000
Present value of purchase option = $13,000 x PV factor of a future amount
=> $13,000 x 0.5674 = $7,376.20

Amount to be recovered through periodic lease payments = $66,000 - $7,376.20 = $58,623.80

Annual lease payments = $58,623.80/4.03735 = $14,520.37

Situation 2:

Fair value of leased asset = $423,000
Present value of purchase option = $53,000 x PV factor of a future amount
=> $53,000 x 0.6499 = $34,444.70

Amount to be recovered through periodic lease payments = $423,000 - $34,444.70 = $388,555.30

Annual lease payments = $388,555.30/4.239719877 = $91,646.46

Situation 3:

Fair value of leased asset = $188,000
Present value of purchase option = $25,000 x PV factor of a future amount
=> $25,000 x 0.8163 = $20,407.50

Amount to be recovered through periodic lease payments = $188,000 - $20,407.50 = $167,592.50

Annual lease payments = $167,592.50/2.808018168 = $59,683.55