Question

On January 1, 2018, Ivanhoe, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement. (a) The agreement requires equal rental payments at the beginning each year. (b) The fair value of the building on January 1, 2018 is $5500000; however, the book value to Holt is $4450000. (c) The building has an estimated economic life of 10 years, with no residual value. Ivanhoe depreciates similar buildings on the straight-line method. (d) At the termination of the lease, the title to the building will be transferred to the lessee. (e) Ivanhoe’s incremental borrowing rate is 10% per year. Holt Warehouse Co. set the annual rental to insure a 6% rate of return. The implicit rate of the lessor is known by Ivanhoe, Inc. (f) The yearly rental payment includes $14000 of executory costs related to taxes on the property. Future Value of Ordinary Annuity of 1 Period 5% 6% 8% 10% 12% 1 1.00000 1.00000 1.00000 1.00000 1.00000 2 2.05000 2.06000 2.08000 2.10000 2.12000 3 3.15250 3.18360 3.24640 3.31000 3.37440 4 4.31013 4.37462 4.50611 4.64100 4.77933 5 5.52563 5.63709 5.86660 6.10510 6.35285 6 6.80191 6.97532 7.33592 7.71561 8.11519 7 8.14201 8.39384 8.92280 9.48717 10.08901 8 9.54911 9.89747 10.63663 11.43589 12.29969 9 11.02656 11.49132 12.48756 13.57948 14.77566 10 12.57789 13.18079 14.48656 15.93743 17.54874 Present Value of an Annuity Due of 1 Period 5% 6% 8% 10% 12%  1 1.00000 1.00000 1.00000 1.00000 1.00000  2 1.95238 1.94340 1.92593 1.90909 1.89286  3 2.85941 2.83339 2.78326 2.73554 2.69005  4 3.72325 3.67301 3.57710 3.48685 3.40183  5 4.54595 4.46511 4.31213 4.16986 4.03735  6 5.32948 5.21236 4.99271 4.79079 4.60478  7 6.07569 5.91732 5.62288 5.35526 5.11141  8 6.78637 6.58238 6.20637 5.86842 5.56376  9 7.46321 7.20979 6.74664 6.33493 5.96764 10 8.10782 7.80169 7.24689 6.75902 6.32825 What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.) $718975 $154975 $690975 $704975

Answer 1

Solution :

Minimum Lease Payment = Cost of asset (or Loan Taken if it differs)

                                           1 + PVAF(r %,n-1 year)

                                        = $ 55,000,00

                                           1 + 6.33493

                                       = $ 7,49,837 (approx)

Total annual lease payment = $ 7,49,837 + $ 14,000

                                         = $ 7,63,837 (aprrox)