CFA Practice Question

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CFA Practice Question

On December 31, 2011, Numark Co. leased a machine from Hardie Ltd. for a five-year period. Equal annual payments under the lease are $315,000 (including $15,000 in annual executory costs) and are due on December 31 of each year. The first payment was made on December 31, 2011, and the second payment was made on December 31, 2012. The five lease payments are discounted at 10% over the lease term. The present value of minimum lease payments at the inception of the lease and before the first annual payment was $1,251,000. The lease is appropriately accounted for as a capital lease by Numark. In its December 31, 2012 balance sheet, Numark should report a lease liability of ______.
A. $951,000
B. $855,900
C. $746,100
Explanation: The amount of the liability is the present value of the lease payments on December 31, 2011 less the payment made in 2011 plus the executory costs.
$1,251,000 - $315,000 + $15,000 = $951,000 (2011)
$951,000 - [$300,000 - ($951,000 x .10)] = $746,100 (2012)

User Contributed Comments 19

User Comment
kalps Good question
shasha why no amortization on net leased asset in 1st year? i mean, on 12/31/2011 after lease payment was made, pv of the asset shown on b/s should be: $1,251,000 - [300,000-(1,251,000*.10)] = $1,076,100 for $15,000 executory cost (whatever it is for), believing it went to P&L.
shasha pls ignore my last posting, i know it's "annuity due", the first $300,000 was deducted from pv to get the beginning lease liability of $951,000.
Abde 951000 - Beginning Balance.
300000 - Annual Rental Pay.
Interest Expense - 951000 * .1
- 95,100.
Ending Balance = 951,000 - (300,000 - 95,100)
= 7,46,100.
The Bottom Line is only the amort. expenses is deducted from the liability.
elda The 15,000 execution cost is irrelevant, so simply:
(1,251,000-300,000)*1.1 - 300,000 = 746,100
Joee Well done, Elda. Keep postin simple explanations!
volkovv or another way:
gene80 can i ask why aren't we segregating the cash outflow of 300,000 into principal and interest. Cos only principal payment deducts the liability right?
gene80 oh.. annuity due. sorry.
gene80 nono.. becos it was paid now means that there wasn't any interest accrued. Hence the amount paid now flows directly to principal, hence, the immediate deduction of 1,251K. Y'all just messing around with the numbers, not even giving proper financial answers.
CoffeeGirl 2012
beginning carrying value = 1251000 - 300000 = 951000
interest expense = 951000 *0.1 = 95100
cash payment for 2012 = 300000
ending carrying value = 951000 - 300000 + 95100 = 746100
steved333 Nix the exec cost: 300k
Subtract from original PV: 1251k-300k= 951k
next year's PV= 951k*1.1-300k=1046k-300k=746100
jackwez alot of these questions you can also knock out by comparing the cash flows to the actual balance... $1251 - $600K = $651K... while not exact all the others are not even close which will help you eliminate answers if you are crunched for time on the exam.
ManuB What is "Annuity due"?
cahiz84 what is: annual executory costs?
poomie83 I got this question wrong but it is actually pretty straight forward problem.

I like working with the whole numbers because it is easier to understand so below is my example:

imagine you borrow $1m (also the PV) at 10% interest and annual payments of $300k over 5 yrs.

Interest accrues the whole time the liability is outstanding.

Each repayment knocks down the principal but interest still gets added on top

After yr 1: $1m x 1.10 - 300 = $800k left
yr 2: $800k x 1.1 - 300 = $580k and so on
homersimpson Use the calculator (BGN mode):
PMT= -300,000 (ignore executory cost)
FY=0, that go to amortization, choose P1, P2 =2
you will see Bal 746,100
rjdelong Draw the line segment and see that after the 2 first payments you have 3 remaining. They will come at the END of each of the next 3 years.

This question converts from annuity due to regular annuity.

I/Y =10
PMT = 300,000
--> PV = 746,100
ashish100 god damn.. that was an intense question. i love it tho
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