Question

Teal Mountain Inc. wishes to lease machinery to Thiensville Company. Thiensville wants the machinery for 4 years, although it has a useful life of 10 years. The machinery has a fair value at the commencement of the lease of $40,000, and Teal Mountain expects the machinery to have a residual value at the end of the lease term of $28,000. However, Thiensville does not guarantee any part of the residual value. Thiensville does expect that the residual value will be $38,000 instead of $28,000. What would be the amount of the annual rental payments Teal Mountain demands of Thiensville, assuming each payment will be made at the end of each year and Teal Mountain wishes to earn a rate of return on the lease of 5%? (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.)

Answer 1

Answer:

Present value of Expected residual value                     = Expected residual Value x PVF (5%, 4 Years)                     = $ 28,000 x 0.82270                     = $ 23,035.60

Amount of equal Annual lease payments      = (Fair value (-) Present value of Expected residual value )/ PVAF (5%, 4 Years)      = ( $ 40,000 (-) $ 23,035.60) / 3.54595       =   $ 16,964.40 / 3.54595       =   $ 4,784

Amount of equal Annual lease payments = $ 4,784