Question

Larkspur Inc. wishes to lease machinery to Thiensville Company. Thiensville wants the machinery for 4 years, although it has a useful life of 10 years. The machinery has a fair value at the commencement of the lease of $46,000, and Larkspur expects the machinery to have a residual value at the end of the lease term of $28,000. However, Thiensville does not guarantee any part of the residual value. Thiensville does expect that the residual value will be $44,000 instead of $28,000.

What would be the amount of the annual rental payments Larkspur demands of Thiensville, assuming each payment will be made at the end of each year and Larkspur wishes to earn a rate of return on the lease of 6%?

Answer 1

Annual lease payment = $6874.69

Step-by-step explanation:

Computation of annual rental payment:

Residual value = 28000

present value (6%,4Yr) = 0.79209

Present value = 28000 x 0.79209

present value of residual value = $22178.52

Fair value of machine = $46000

Less: present value of residual value =22178.52

Amount recover from lease = Fair value of machine minus present value of residual value

Amount recover from lease = $46000 - $22178.52

Amount recover from lease = $23821.5

Annual lease payment = Amount to be recover from lease divided by present value Annuity factor (6%,4yr)

Annual lease payment = 23821.5/3.46510

Hence,

Annual lease payment = $6874.69