Lease payment question

CFA Level I
#1

It seems to me that sometimes, when a capital lease is starting, the entire first payment goes through CFO (i.e. no interest yet, since lease just started, so first payment all flows through CFO), and yet other times that seems not to be the case (see question 63, Bk 6 exam 1pm: Mgmnt is considering a new lease: Fair mkt value $2.8 mm, life of 10 years, no salvage Incremental borrowing rate 11.5 Lease term 7 years, lease payments of $41567 due at beginning of each month Implicit lease rate: 10% No bargain purchase option If mgmnt leases machine: a) current ratio is unaffected (I know this is wrong, CL would increase by the current portion of liability b) the lease period is greater than 75% of useful life (also wrong) c) in first month, cash flow from ops will decrease by 41,567 (my choice) d) In first month, cash flow from ops will decrease by $21,039 (correct choice) My question is, why, if this is the first month, is there any interest cost? I’ve seen other probs where it said payment at lease inception is ALL principle. Have at it, thanks

#2
  1. This question has been discussed many times. 2. You have made the same standard mistake - which was a. You missed that the payments were beginning of period. b. Rate should have been 10% not 11.5% With the above 2 – it would have been a Capital Lease – because value of PV(MLP) > 90% (by just a small wee bit) of the Fair Value of the equipment. So Interest payment becomes 10% of the PV(MLP) = 21039. Check it out. CP
#3

I know it’s a capital lease, and I know that 10% is the interest rate, and I know that it’s at beginning of period. My question is why is the interest being applied to it, rather than it all going to principle? It’s at lease inception, and I’ve seen other questions that explained that any lease payment at lease inception goes right to principle, no interest.

#4

In case all ur payments went in the first yr , CFO shouldnt be affected at all since it should be CFF then

#5

The payment made goes part to interest and part to principle always. In all problems. There is a reduction in Principle - which goes to CFF and an interest portion that goes to CFO.

#6

thanks for your help

#7

can someone explain how your arrive at the PV(MLP)? I get 2,054,775.98… thanks.

#8

Looks like ur in the begin mode of the calculator?

#9

use begin mode… BGN I/Y=10/12=0.83333 PMT=41567, N=84 PV = 2524723

#10

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#11

Hi Smarshy, Look this up http://www.analystforum.com/phorums/read.php?11,635122,635125#msg-635125 Here the payments are made in the beginning too, but for the first payment everything goes to the principal. Interest is calculated after that first payment is made.

#12

Thanks smeet! Cpk123, in another thread you wrote this: Posted by: cpk123 (IP Logged) [hide posts from this user] Date: November 27, 2007 09:06AM 1. 10% is being used (in answer to Niraj’s question) because that is the rate implied in the Lease. 2. ZXL, this lease is being paid in the beginning of period. So on Jan 1,2005 – you signed the lease for 151307 Made an immediate lease payment of 36,285.90 So lease balance is : 151307 - 36285.90 = 115021.1 Then over the year the 10% interest kicks in --> 11502.11 What I don’t understand is the difference between this example and my example. Why is interest charged in my example, but not yours?

#13

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