Question

The following separate scenarios relate to a 5-year lease, pertaining to equipment with a fair value of $25,000. Assume in all scenarios that payments are made at the beginning of the period.

1. Lease payments include a fixed payment of $5,000 per year.

2. Lease payments include a fixed payment of $5,000 per year, plus $250 for insurance and $300 for a maintenance contract.

3. Lease payments will be $5,000 in the first year and will increase by 3% (calculated on the previous year's payment) for each of the following 4 years.

4. Lease payments will be $5,000 in the first year and will increase each of the following years by the increase in the CPI from the preceding year. The current CPI is 120 and is expected to increase to 122 at the end of the next year.

5. Lease payments will be $5,000 in the first year and will increase each of the following years by (a) the increase in the CPI from the preceding year, or (b) 3%, whichever is greater. The current CPI is 120 and is expected to increase to 122 at the end of the next year.

6. Lease payments include a fixed payment of $5,000 per year. In addition, the lessee has guaranteed the residual value of the equipment for $1,000 at the end of the lease.

Required

For each of the six separate scenarios outlined above, and considering only the fair value lease criterion, determine how the lessee would classify the lease, assuming a discount rate of 7%.

PV of Lease Payments	90% of Fair Value	Lease Classification
1
2
3
4
5
6

Answer 1

	PV of Lease Payments	90% of Fair Value	Lease Classification
1	21,900	22,500	Operating
2	24,090	22,500	Finance
3	23,149	22,500	Finance
4	22,140	22,500	Operating
5	23,149	22,500	Finance
6	22,649	22,500	Finance

If present value of lease payments is 90% or more it is classified as fiance lease otherwise operating lease.

sum of present value at 7% at the beginning=3.38

Pv of lease payments may differ based on decimal points taken, i have calculated using two decimal points