Chapter 5: Q20BP-b (page 531)

The Deluxe Corporation has just signed a 168-month lease on an asset with a 19-year life. The minimum lease payments are $1,300 per month ($15,600 per year) and are to be discounted back to the present at a 9 percent annual discount rate. The estimated fair value of the property is $165,000.
b. Calculate the present value of lease payments as a percentage to the fair value of the property.

Expert verified

The present value of lease payments is 73.6% of the fair value of the asset.

Step by step solution

Time of lease = 168 month

Life of asset = 19 years

Minimum monthly payments = $1,300

Minimum annual payments = $15,600

Discount rate = 9%

Estimated fair value of asset = $165,000

The present value of lease payments is $121,465.

$PV of lease payments = Annual lease payments \times {PVFA}_{(i = 9 %, n = 14 y e a r s)} = $ 15, 600 \times 7.7862 = $ 121, 465$

The present value of lease payments is 73.6% of the fair value of the asset.

$Percentage of fair value = \frac{PV of lease payments}{Fair value of asset} \times 100 = \frac{$ 121, 465}{$ 165, 000} \times 100 = 73.6 %$

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Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder’s equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder’s equity	\)15,680,000
Total liabilities and stockholder’s equity	$28,650,000