Question

(CO E) Jack Sawyer is presently leasing a copier from John Office Equipment Company. The lease requires 11 annual payments of $2,500 at the end of each year and provides the leaser (John) with an 8% return on its investment. You may use the following 8% interest factors.

	9 Periods	10 Periods	11 Periods
Future Value of 1	1.99900	2.15892	2.33164
Present Value of 1	.50025	.46319	.42888
Future Value of Ordinary Annuity of 1	12.48756	14.48656	16.64549
Present Value of 1	6.24689	6.71008	7.13896
Present Value of Ordinary Annuity of 1	6.74664	7.24689	7.71008

(a) Assuming the computer has an 11-year life and will have no salvage value at the expiration of the lease, what was the original cost of the copier to John?
(b) What amount would each payment be if the 11 annual payments are to be made at the beginning of each period?

Answer 1

a)the computer has an 11-year life and will have no salvage value at the expiration of the lease, what was the original cost of the copier to John = Presnet value of all annual payments at the rate of 8%

= 2,500*PVAF(8% , 11 periods)

= 2,500*7.13896

= $17,847.4

Since the payments are made at the end of each period, it is the case of annuity due

b)Since the payments are made at the beginning of each period, it is the case of ordinary annuity

Annual Payment = Actual Cost/(1+PVAF(8%, 10 periods)

= 17,847.4/(1+7.24689)

= $2,164.14 (approx.)

Since in ordinary annuity payments are made at the beginning, the interest cost is lower compared to annuity due and hence instalment amount is always smaller.