Question

Refer to the following lease amortization schedule. The five payments are made annually starting with the inception of the lease. A $2,000 bargin purchase option is exercisable at the end of the five-year lease. The asset has an expected economic life of eight years.

Lease Payment Cash Payment Effective Interest Decrease in Balance Balance
34,600
1 8,000 ?? ?? 26,600
2 8,000 2,660 5,340 21,260
3 8,000 2,126 5,874 15,386
4 8,000 1,539 6,461 8,925
5 8,000 ?? ?? ??
6 2,000 182 1,818 0
What is the effective annual inerest rate?
A. 9%
B. 10%
C. 11%
D. 20%

Answer 1

B. 10%

Explanation:

The computation of the effective annual interest rate is shown below:-

Effective annual interest rate = Lease payment third effective interest ÷ Lease payment second balance × 100

= $2,126 ÷ $21,260 × 100

= 10%

Therefore for computing the effective annual interest rate we simply applied the above formula.

Hence the correct option is B.