Question

Bristol Company leased a machine from Harvard Leasing Company on January 1, 2017. The non-cancellable lease term is 4 years. The following data relate to this lease:

1. Harvard purchased the machine for $363,950 at a cost equal to its fair market value.
2. The economic life of the machine is 6 years with no salvage value at the end of 6 years.
3. Payments are on January 1 of each year starting in 2017 (an annuity due).
4. The annual rental payment is $100,000 which includes $8,000 per year to cover executory costs paid by Harvard Leasing. (i.e., the minimum lease payment is $92,000). The executory costs are for taxes and can vary after the first year if taxes increase.
5. The machine will be returned to Harvard Leasing with an estimated residual value of $40,000 at the end of the lease term.
6. Bristol's incremental borrowing rate per year is 10%.
7. Future costs associated with this lease are predictable and no uncertainties exist about collectability of lease payments.

Assume that the residual value is not guaranteed by Bristol Company and also that Bristol does not know Harvard's implicit interest rate. Perform the 90% test for Harvard and Bristol. Use the PV function to calculate the present value of the minimum lease payments for both parties. Divide the present value by the fair market value of the machine and report your results as percentages.

(Please show the formulas used in Excel)

Answer 1

considered as negative as negative 1 sign) 2 Year (beginning) 363950 Cash flow 92000 92000 92000 92000 0.07 4 2 4 6 7 Rate function 8 Remarks for use of rate function rate (4,92000, -363950, 40000, 1)

90 % test for Horward Leasing Fair Market Value: $ 363,950 Annual interest rate: 7.00% Minimum lease payment: $92,000 Residual value: $40,000 Present Value-92000 * PVIFA (4 y, 7%) + 40000 * PVIF (4 y, 7%) 92000 *3.3872 + 40000* .7629 311622+30516 342 138 > 90 % of 363 950 90% test is satisfied Present value to fair market value 342138 /363950 * 100 94% 90% test for Bristol Leasing Bristol's incremental borrowing rate per year is: 10% Minimum lease payment: $92,000 Present Value = 92000 * PVIFA (4 y, 10%) 92000*3.16986

291627 -291627 < 90 % of 363 950 90% test is not satisfied Present value to fair market value 291 627 /363 950 *100-80. 12% Note: Executor cost not to be taken as it is separate cost and it is specific in question. Calculation is made on MLP Bristol will use 10% given rate relating to harvare. It is assumed residual value will realize in hand of Harvard at the end of 4th year. If we take the 7 % then PV for Bristol will be-31 1622, 85.62%, 90% Test not Satisfied. Assumed it is not of Harvard rate treat as general market rate. 1. 2. as Bristol does not know Harvard's implicit interest rate assumed 3. 4.