Question

Brief Exercise 21A-8 Cardinal Company is negotiating to lease a piece of equipment to MTBA, Inc. MTBA requests that the lease be for 9 years. The equipment has a useful life of 10 years. Cardinal wants a guarantee that the residual value of the equipment at the end of the lease is at least $5,000. MTBA agrees to guarantee a residual value of this amount though it expects the residual value of the equipment to be only $2,500 at the end of the lease term. If the fair value of the equipment at lease commencement is $70,000, what would be the amount of the annual rental payments Cardinal demands of MTBA, assuming each payment will be made at the beginning of each year and Cardinal wishes to earn a rate of return on the lease of 8%? (For calculation purposes, use 5 decimal places as displayed in the factor table provided and round final answer to o decimal places, e.g. 5,275.) Click here to view the factor table. Amount of equal annual lease payments &

Answer 1

Solution:

Present value of Residual Value = $5000 * Present value of $1 @8% at 9th period

= $5000 * 0.50025 = $2501.25

Amount To be recovered through Lease payments = Fair value of Equipment - Present value of Residual Value

= $70000 - $$2501.25 = $67,498.75

Amount of equal Annual Lease payment = $67,498.75 * Present value of Annuity of $1 @8% for 9 periods

= $67,498.75 * 6.74664 = $10,005