Question

Quest Inc. is negotiating an agreement to lease equipment to a lessee for 8 years. The equipment has a useful life of 10 years. The fair value of the equipment is $80,000 and the lessor expects a rate of return of 8% on the lease contract. The lessee guarantees a residual value of $20,000 at the end of the 8-year lease term. If the first annual payment is required at the end of the first year following the commencement of the lease, what fixed lease payment should Quest Inc. charge in order to earn its expected rate of return on the contract? Note: Round Answer two decimal places

Answer 1

Ans.

Lease Agreement:-

A lease agreement is a contract between a lessor (landlord) and lessee that covers the renting for specific period of time. The lessee guarantees to lessor for regular payment for a specific period of time.

Calculate the amount of fixed annual lease payment:

Fair value of equipment	$80,000
Less:- Present value of guaranteed residual value	$10,805.4
Amount to be recovered through lease payments (A)	$69,194.6
Cumulative present value annuity factor at 8% for 8 years (B)	6.20637
Amount of fixed annual lease payments (A / B)	$11,148.96

Working Notes:-

Present value of residual value:

Guarantee residual value (A)	$20,000
Cumulative present value factor at 8% for 8 years (B)	0.54027
Present value of guaranteed residual value (A x B)	$10,805.4

Hence, the amount of fixed annual lease payment is $11,148.87.