Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c }
& \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \
\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \
\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022
\end{array}$$
-The lease liability will be valued on Pepper's balance sheet at (Round all calculations to the nearest whole dollar amount.)

Question

Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessor's implicit lease rate, known to the lessee, is 10%.
Present value interest factors are:
$$\begin{array} { l c c } 
& \underline { \mathbf { 1 0 \% } } & \underline { \mathbf { 1 2 \% } } \
\text { PVIF \$1 } 10 \text { periods } & 0.38554 & 0.32197 \
\text { PVIF Annuity } 10 \text { periods } & 6.14457 & 5.65022
\end{array}$$
-The lease liability will be valued on Pepper's balance sheet at (Round all calculations to the nearest whole dollar amount.)

Quizplus · Accepted Answer

To calculate the lease liability that will be recorded on Pepper's balance sheet, we need to consider the present value of the lease payments and the guaranteed residual value. The lease payments are $25,000 annually for 10 years, and the guaranteed residual value is $10,000. The interest rate used by Pepper (the lessee) is the lesser of the lessee's incremental borrowing rate or the lessor's implicit rate, which is known to the lessee. In this case, the lessor's implicit rate of 10% is lower than Pepper's bank financing rate of 12%, so we use 10%.The present value of the lease payments is calculated using the present value of an annuity factor for 10 periods at 10%, which is 6.14457. Thus, the present value of the lease payments is $25,000 * 6.14457 = $153,614 (rounded to the nearest dollar).The present value of the guaranteed residual value is calculated using the present value interest factor for a single sum for 10 periods at 10%, which is 0.38554. Thus, the present value of the guaranteed residual value is $10,000 * 0.38554 = $3,855 (rounded to the nearest dollar).Adding these two components gives the total lease liability value: $153,614 (lease payments) + $3,855 (residual value) = $157,469.

Pepper, Inc -The Lease Liability Will Be Valued on Pepper's Balance Sheet