Question

For Firm A’s lease of equipment which has an annual payment of $100,000, what is the balance of the lease liability that would be presented on the balance sheet if there are 7 years left on the life of the lease? The contract interest rate is 5%, and firm A has already made the payment for the past year.

Select one:

a. $100,000 x 4.32948 (Present Value of Annuity of $1 @ 5% for 5 periods) = $432.948

b. $100,000 x 5.78637 (Present Value of Annuity of $1 @ 5% for 7 periods) = $578,637

c. $100,000 x 5.07569 (Present Value of Annuity of $1 @ 5% for 6 periods) = $507,569

d. $100,000 x 4.10020 (Present Value of Annuity of $1 @ 7% for 5 periods) = $410,020

Answer 1

Annual payment = $100,000

Annual lease payments are to be paid for 7 years

Interest rate = 5%

Since equal amounts are to be paid annually, it is a case of annuity.

First lease payment will me made at the beginning of the first year. Hence, annual payments for lease will be made for 6 more years.

Hence, Present Value of Annuity of $1 @ 5% for 6 periods will be used to calculate present value of lease liability.

Lease liability = $100,000 x 5.07569  (Present Value of Annuity of $1 @ 5% for 6 periods) = $507,569.

Correct option is (C)