Belfor Manufacturing Limited has $878 010 in total assets, $272 555 in equity and $605 455 inliabilities. The company is considering a lease with $40 776 in annual lease payments for 6 years.The first lease payment is due upon signing the lease contract. The company's tax rate is 33% and its borrowing rate is 6%. The lessor's implied discount rate is 6.85%, the cost of the asset is $238 926 and the asset's economic life is estimated at 8 years. Which of the following statements about Belfor's considered lease is correct?
A) On the day the lease is signed, the capitalized value of the lease would be $222 202 after rounding.
B) The lease should not be capitalized since the term of the lease is only 67% of the asset's economic life
C) The contract would be considered a conditional sales arrangement since the economic life of the asset is longer than the term of the lease.
D) This lease would not be considered a financial (capital) lease since the present value of the lease is less than 90% of the asset's fair market value.

Question

Quizplus · Accepted Answer

To determine whether the lease should be capitalized, we need to calculate the lease's present value (PV) using the lessor's implied discount rate of 6.85%, which is the rate used to determine the lease payments. Using a financial calculator or Excel, we can find that the PV of the lease is $222,202 after rounding.

Next, we need to compare the PV of the lease to the asset's fair market value (FMV), which is $238,926. Since the PV of the lease is less than the 90% of the FMV ($215,033.4), the lease would not be considered a financial (capital) lease.

Therefore, B and D are incorrect choices.

Regarding choice C, the economic life of the asset is longer than the term of the lease, but that alone does not make the contract a conditional sales arrangement. To be considered as such, the contract would need to transfer ownership of the asset to the lessee at the end of the lease term, which is not provided in the question.

Belfor Manufacturing Limited Has $878 010 in Total Assets, $272