CFA Practice Question

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CFA Practice Question

West Company leased a new machine from South Company on May 1, 2015 for 10 years with annual lease payments of $40,000 at the start of each lease year. The machine has an estimated useful life of 12 years. The appropriate discount rate to be used is 14% and the present value of $1 for 10 periods at 14% is 0.27. The present value of an annuity of $1 for 10 periods at 14% is 5.95. The lease contract included a residual value guarantee of $50,000. West should record a capitalized leased asset on their books of ______.

A. $251,500
B. $238,000
C. $224,500
Correct Answer: A

Since it is guaranteed, the $50,000 residual value is discounted as a lump sum for 10 years at 14%. The $40,000 lease payment is an annuity that is discounted. The correct computation is [($50,000 * .27) + ($40,000 * 5.95)] = $13,500 + $238,000 or $251,500.

User Contributed Comments 11

User Comment
kalps NB it is guaranteed so it will be paid at the end of teh period. If it was an option then you would look at the probability of exercising that option and make a conservative estimate
isida the residual value guarantee is discounted as a lump sum
o123 ** PV OF THE $1 ANNUITY IS NOT 5.95, ITS 5.216!!

Value of 40,000 annuity: N=10, i/y=14, pmt=40,000 CPT PV= 208,645
value of 50,000 Lump sum: N=10, i/y=14, FV=50,000 CPT PV= 13,487
BV; 13,487 + 208,645 = 222,132
o123 Wow...sorry people I'm going to have to take back that last comment once again...and take my hat off to the people at AN aswell.
Just noticed the fine print: the lease payment is at the beginning of the period (Annuity Due)! so set your calc to the BGN mode and run the same calculations.
quynhnk79 Great, you so responsible man! Thank you.
quanttrader add PV of guarantee to PV of lease payment annuity.
thekobe just make the calculation of the annuity and you get $238, but since you have to include the residual value, the answer should be greater, so your choice is A
johntan1979 If you used the TVM menu, the answer is $251,342 due to rounding differences.
gill15 Problem with this question is it say the PV of an annuity of 1 for 10 periods = 5.95. They should tell us if the PV value of the annuity of 5.95 pertains to an annuity due or immediate. I assumed the 5.95 was for immediate but its due.
Shaan23 With Lease payments at BOYear this is an annuity due. It does NOT state if 5.95 is for an anuity due or immediate. With first reading I would say it is Annuity immediate and needs to be converted.
farrahkame lol what.
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