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.
Situation 1 Situation 2 Situation 3
Lease term (years) 5 10 4
Lessor?s rate of return 10% 11% 9%
Fair value of leased asset $62,000 $421,000 $186,000
Lessor?s cost of leased asset $51,000 $421,000 $146,000
Bargain purchase option:
Option price $11,000 $51,000 $23,000
Exercisable at end of the year: 5 5 3

Required:
Determine the annual lease payments for each situation:

Answer 1

Answer:

a. The annual lease payment for Situation 1 is $12,774.47.

b. The annual lease payment for Situation 2 is $71,486.40.

c. The annual lease payment for Situation 3 is $57,412.37.

Explanation:

The annual lease payments can be calculated using the formula for calculating loan amortization as follows:

P = (A * (r * (1 + r)^n)) / (((1+r)^n) - 1) .................................... (1)

Where,

For Situation 1

P = Annual lease payments = ?

A = Fair value of leased asset = $62,000

r = interest rate = Lessor’s rate of return = 10%, or 0.01

n = Number of years of lease term = 5

Substituting all the figures into equation (1), we have:

P = ($62,000 * (0.01 * (1 + 0.01)^5)) / (((1+0.01)^5) - 1)

P = $12,774.47

Therefore, the annual lease payment for Situation 1 is $12,774.47.

For Situation 2

P = Annual lease payments = ?

A = Fair value of leased asset = $421,000

r = interest rate = Lessor’s rate of return = 11%, or 0.11

n = Number of years of lease term = 10

Substituting all the figures into equation (1), we have:

P = ($421,000 * (0.11 * (1 + 0.11)^10)) / (((1 + 0.11)^10) - 1)

P = $71,486.40

Therefore, the annual lease payment for Situation 2 is $71,486.40.

For Situation 3

P = Annual lease payments = ?

A = Fair value of leased asset = $186,000

r = interest rate = Lessor’s rate of return = 9%, or 0.09

n = Number of years of lease term = 4

Substituting all the figures into equation (1), we have:

P = ($186,000 * (0.09 * (1 + 0.09)^4)) / (((1 + 0.09)^4) - 1)

P = $57,412.37

Therefore, the annual lease payment for Situation 3 is $57,412.37.