# Lease question

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

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

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.

i also got D.

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

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

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

obviously 90%…haha

Thanks Maratikus

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.

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

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

D

And the correct is D, good stuff.

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

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

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

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