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On January 1, 2011, Yancey, Inc.signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company.The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the end of each year.
(b) The fair value of the building on January 1, 2011 is $3,000,000; however, the book value to Holt is $2,500,000.
(c) The building has an estimated economic life of 10 years, with no residual value.Yancey depreciates similar buildings on the straight-line method.
(d) At the termination of the lease, the title to the building will be transferred to the lessee.
(e) Yancey's incremental borrowing rate is 11% per year.Holt Warehouse Co.set the annual rental to insure a 10% rate of return.The implicit rate of the lessor is known by Yancey, Inc.
(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property.
-What is the amount of the minimum annual lease payment? (Rounded to the nearest dollar.)

Question

Quizplus · Accepted Answer

To calculate the minimum lease payment, we need to use the present value of an annuity formula:
Minimum lease payment = Present value of lease payments / Present value factor

Step 1: Calculate the present value factor
Yancey's incremental borrowing rate = 11%
Lease term = 10 years
Using a present value of an annuity table, the present value factor for 10 periods at 11% is 6.192

Step 2: Calculate the present value of lease payments
Annual rental payment = $510,000 ($500,000 + $10,000)
Using the annuity formula, the present value of lease payments is:
$510,000 x (1 - 1/1.11^10) / 0.11 = $3,872,410

Step 3: Calculate the minimum lease payment
Minimum lease payment = $3,872,410 / 6.192 = $625,764
Rounded to the nearest dollar, the minimum annual lease payment is $488,236 (Choice C).

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