Question

Morgan Leasing Company signs an agreement on January 1, 2017, to lease equipment to Cole Company. The following information relates to this agreement.

1. The term of the noncancelable lease is 6 years with no renewal option. The equipment has an estimated economic life of 6 years.
2. The cost of the asset to the lessor is \(245,000. The fair value of the asset at January 1, 2017, is \)245,000.
3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have a residual value of $43,622, none of which is guaranteed.
4. Cole Company assumes direct responsibility for all executory costs.
5. The agreement requires equal annual rental payments, beginning on January 1, 2017.
6. Collectibility of the lease payments is reasonably predictable. There are no important uncertainties surrounding the amount of costs yet to be incurred by the lessor.

Instructions

(Round all numbers to the nearest cent.)

(a) Assuming the lessor desires a 10% rate of return on its investment, calculate the amount of the annual rental payment required. (Round to the nearest dollar.)

Short answer

Six periodic lease payments are $46,000.00.

Step-by-step solution

Meaning of Lease

The lease process requires the lessor to transfer his asset to the lessee,as well as the right to use the asset for an agreed contract period, for which the lessor changes some amount to the lessee as the payment for the lease.

Calculating amount of the annual rental payment required

The fair value of the leased asset to the lessor	$245,000.00
Less: Present value of unguaranteed residual value $43,622 X .56447 (Present value of 1 at 10% for 6 periods)	24,623.31
Amount to be recovered through lease payments	$220,376.69
Six periodic lease payments	$46,000.00

Working Notes:

Computation of Six periodic lease payments

$\begin{array}{rcl}\mathrm{Six}\mathrm{periodic}\mathrm{lease}\mathrm{payments}& =& \frac{\mathrm{Amount}\mathrm{recovered}\mathrm{through}\mathrm{lease}\mathrm{payment}}{\mathrm{Present}\mathrm{value}\mathrm{of}\mathrm{annuity}}\\ & =& \frac{\$220,376.69}{4.79079}\\ & =& \$46,000.00\end{array}$

Note: Present value of an annuity due of 1 for 6 periods at 10%.

Rounded to the nearest dollar.