The Deluxe Corporation has just signed a 120-month lease on an asset with a 18-year life. The minimum lease payments are $2,600 per month ($31,200 per year) and are to be discounted back to the present at a 12 percent annual discount rate. The estimated fair value of the property is $230,000. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the lease is set up as an annual lease.

The Deluxe Corporation has just signed a 120-month lease on an asset with a 18-year life. The minimum lease payments are $2,600 per month ($31,200 per year) and are to be discounted back to the present at a 12 percent annual discount rate. The estimated fair value of the property is $230,000. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods. Assume the lease is set up as an annual lease.

  

a.	Calculate the lease period as a percentage to the estimated life of the leased property. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

  

Lease period percentage

%

  

b.	Calculate the present value of lease payments as a percentage to the fair value of the property. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

 

PV of lease payment percentage

%

 

c.	Should the lease be recorded as a capital lease or an operating lease? (Use criteria 3 and 4 for a capital lease.)
	Operating lease

 
Explanation:

a.

Percentage	= Lease period / Property life
	= (120 / 12) / 18
	=.5556, or 55.56%

The lease is less than 75 percent of the estimated life of the leased property.

b.

PV of lease payments	=	$31,200 × ({1 − [1 / 1.1210]} / .12)
	=	$-176,286.96

Percent	= PV of lease payments / Property fair market value
	= $-176,286.96 / $230,000
	= .7665, or 76.65%

The present value of the lease payments is less than 90 percent of the fair market value of the leased property.

c.

Since none of the four criteria for compulsory treatment as a capital lease is indicated, the transaction must be treated as a operating lease.

   

Calculator Solution:

b.

	N			I/Y			PV			PMT			FV
10			12			CPT PV −-176,286.96			31,200			0

   

PV of lease payments = $-176,286.96

   

Appendix Solution:

PV of lease payments	= Annual lease payment × PVIFA (12%, 10)
	= $31,200 × 5.650
	= $176,280.00

PV of lease payment percentage	= PV of lease payments / Property fair market value
	= $176,280.00 / $230,000
	= .7664, or 76.64%