Question

Splish Brothers Company is negotiating to lease a piece of equipment to MTBA, Inc. MTBA requests that the lease be for 9 years. The equipment has a useful life of 10 years. Splish Brothers wants a guarantee that the residual value of the equipment at the end of the lease is at least $4,000. MTBA agrees to guarantee a residual value of this amount though it expects the residual value of the equipment to be only $2,000 at the end of the lease term.

If the fair value of the equipment at lease commencement is $120,000, what would be the amount of the annual rental payments Splish Brothers demands of MTBA, assuming each payment will be made at the beginning of each year and Splish Brothers wishes to earn a rate of return on the lease of 11%? (For calculation purposes, use 5 decimal places as displayed in the factor table provided and round final answer to 0 decimal places, e.g. 5,275.)

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Amount of equal annual lease payments

Answer 1

Fair Value of leased asset	1,20,000	a
Less - PV Guranteed residual Value
Residual Value	4,000	b
* PV factor (11%,9)	0.3909	c
	1,564	d = c*b
Value to be Recovered through Periodic payment	1,18,436	e = a-d
/PVAD (11%,9)(Working)	6.146	f
Annual lease payment at beginning of year	19,270	g = e/f

Working note
Year	PV Factor
1	1.000
2	0.901
3	0.812
4	0.731
5	0.659
6	0.593
7	0.535
8	0.482
9	0.434
Total	6.146