Lease question

CFA Level I
#1

Machine has fair value = 2.8 million, estimated life of 10 yrs, no salvage value Incremental Borrowing Rate = 11.5% Lease term = 7 yrs. with lease payments = 41,567 due at beginning of each month. Implicit lease rate = 10.0% Lease does not contain a BPO, and there is no title transfer at the end of lease. If mgmt leases the machine: A) the current ratio is unaffected B) The lease period is greater than 75% of the assets useful life C) in the first month cash flow from operations will decrease by approx. $41 567 D) in the first month cash flow from operations will decrease by approx. $21 039

#2

life = 70% PV(MLP) = BGN, PMT=41567, N=84, I/Y=10/12 PV=2524723 % = 2524723/2800000 = 90.17% So capital lease Int Exp: 2524723 * 10/1200 = 21039 Ans D

#3

Tricky. I first picked C because I thougt it was an operating lease. Then I saw cpk’s calculations and realized I had to switch to BGN mode.

#4

i also got D.

#5

Is it cap. lease if MLP > 90% or 75%?

#6

D. yes begin more… :slight_smile: otherwise you would get less than 90%.

#7

MLP > 90% or lease term >75% of useful life

#8

obviously 90%…haha

#9

Thanks Maratikus

#10

I’m having a roadblock…where and why do you have 10/1200. I get 1/120 (1 month out of 120 months), which equals to 10/1200, but just curious why you are using 10/1200.

#11

man… this was a cruel question … answer is D, but on exam day, would have surely picked C - Dinesh S

#12

10/1200 (for the interest rate for a month) 10% / 12… or 10/1200.

#13

D

#14

And the correct is D, good stuff.

#15

Picked A thinking that it’s Operating Lease. BTW, Current Ratio is unaffected assuming it is a Operating Lease. Ya? Thanks. CPK nails it down

#16

maparam and others if it had been an operating lease – C would have been a choice (since Rent expense would show up in CFO). so would A actually. given that 2 answers are not possible … for the same question, it had to be something else. CP

#17

Dumb question, I can’t remember right now. What are the entries for an operating lease causing no effect on the current ratio?

#18

the only entry for an operating lease for the Lessor is the Rent expense that shows up on the Income statement (as an expense). For the Lessee - Operating lease is an “off-balance” sheet financing item – so will never show up there, only on the footnotes. (I guess) CP