Question

Mid-South Auto Leasing leases vehicles to consumers. The attraction to customers is that the company can offer competitive prices due to volume buying and requires an interest rate implicit in the lease that is one percent below alternate methods of financing. On September 30, 2021, the company leased a delivery truck to a local florist, Anything Grows. The fiscal year for both companies ends December 31.


The lease agreement specified quarterly payments of $3,000 beginning September 30, 2021, the beginning of the lease, and each quarter (December 31, March 31, and June 30) through June 30, 2024 (three-year lease term). The florist had the option to purchase the truck on September 29, 2023, for $6,000 when it was expected to have a residual value of $10,000. The estimated useful life of the truck is four years. Mid-South Auto Leasing’s quarterly interest rate for determining payments was 3% (approximately 12% annually). Mid-South paid $25,000 for the truck. Both companies use straight-line depreciation or amortization. Anything Grows’ incremental interest rate is 12%.

Calculate the amount of selling profit that Mid-South would recognize in this sales-type lease. (Be careful to note that, although payments occur on the last calendar day of each quarter, since the first payment was at the beginning of the lease, payments represent an annuity due.)

Answer 1

The lease agreement specified quarterly payments of $3,000 beginning September 30, 2021, the beginning of the lease, and each quarter (December 31, March 31, and June 30).

Total number of installments of rent paid till  September 29, 2023, will be 8

The florist had the option to purchase the truck on September 29, 2023, for $6,000 when it was expected to have a residual value of $10,000.so it will be fair to assume that the florist will exercise the option to acquire the truck on September 29,2023 and thereby leading to instant gain of $4000. Thereby the following transaction amounts to finance lease.

Sales price of mid south= Present value of rentals for 8 quarters +present value of sale proceeds on option to purchase date

Dates	Lease rent	Sale proceeds	Present value factor 3% per quarter	Present value of lease rents
30-Sep-21	3000		1	3,000.00
31-Dec-21	3000		0.97	2,912.62
31-Mar-22	3000		0.94	2,827.79
30-Jun-22	3000		0.92	2,745.42
30-Sep-22	3000		0.89	2,665.46
31-Dec-22	3000		0.86	2,587.83
31-Mar-23	3000		0.84	2,512.45
30-Jun-23	3000		0.81	2,439.27
30-Sep-23		6000	0.79	4,736.46
	present value of sale proceeds			26,427.30

Gain on sale of truck of Mid-South Auto Leasing = present value of sales proceeds and lease rentals-purchase costs of truck

=26427.30-25000=1427.30