Final answer:
The lessee uses the incremental borrowing rate to compute the present value of minimum lease payments. The present value, yearly payments for loans, and the valuation of bonds are all determined using interest rates or market discount rates, along with considering the time value of money and interest rate risk.
Step-by-step explanation:
The lessee computes the present value (PV) of the minimum lease payments using its incremental borrowing rate or, if it's determinable, the rate implicit in the lease. The present value is a calculation that determines the current worth of a stream of future payments considering a specific discount rate.
If, for instance, a lessee is expected to pay $12,000 a year for 30 years, the total payment amounts to $360,000. However, taking into account a discount rate and the time value of money, the present value of these payments will be less.
For loans and bonds, calculating the yearly payments or the present value of future payments requires using the interest rate or the market discount rate as part of the formula. For example, if Mackenzie obtains a 15-year student loan for $160,000 with a 6.8% interest rate, her yearly payments would be determined using an amortization formula that takes into account the total loan amount, the interest rate, and the loan term.
Bonds also carry an interest rate risk; if market rates rise after a bond is purchased, newer bonds may offer higher returns, thus devaluing the older bonds with lower interest rates. Computing the present discounted value of future bond payments using various discount rates in response to changing market conditions is essential for investors to determine the true value of their investment.