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Carla Vista, Inc. leased equipment from Tower Company under a 4-year lease requiring equal annual payments...

Carla Vista, Inc. leased equipment from Tower Company under a 4-year lease requiring equal annual payments of $414152, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4 year useful life and no salvage value. Carla Vista, Inc.’s incremental borrowing rate is 11% and the rate implicit in the lease (which is known by Carla Vista, Inc.) is 9%. Assuming that this lease is properly classified as a capital lease, what is the amount of principal reduction recorded when the second lease payment is made in Year 2?

PV Annuity Due

PV Ordinary Annuity
9%, 4 periods

3.53129

3.23972
11%, 4 periods

3.44371

3.10245



$245254
$293396
$319801
$414152
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Answer #1

Solution:

Present value of lease payments = $414,152 * Cumulative PV factor at 9% for 4 periods of annuity due

= $414,152 * 3.53129 = $1,462,491

Interest for first year = ($1,462,491 - $414,152)* 9% = $94,351

Principal reduction in 2nd lease payment = $414,152 - $94,351 = $319,801

Hence 3rd option is correct.

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