### CFA Practice Question

Truman Incorporated has just agreed to lease a piece of machinery from Dewitt Corporation. The terms of the lease specify that Truman pay an initial payment of \$5,000, and then \$4,000 at the end of every year for 10 years. The useful life of the asset is expected to be 15 years. The fair value of the equipment is \$32,500, and Truman's incremental borrowing rate is 10%. What is the present value of the lease payments to Dewitt (to the nearest hundred dollars), and is Truman therefore required to capitalize this lease?
A. Present value = \$29,600, not capitalized.
B. Present value = \$29,600, must capitalized.
C. Present value = \$24,600, must capitalized.
Explanation: The present value of the minimum lease payment is \$5,000 + (\$4,000 x 6.145) = \$29,600. As this is more than 90% of the current fair value of the equipment, this lease has to be capitalized.

User Comment
Vaughan Where does the 6.145 come from?!
jayjunk 6.145 is the value of an annuity of \$1 for 10 years at discount rate 10%.
molloycm You can also use the cashflow function on the calculator to get the NPV of \$29,600. \$29,600/\$32500 = 91% of FV which means the lease can be capitalised.
bahamas hp 12 c: N - 10, i - 10, FV - 0, PMT - chs 4000, PV = 24578.27 + initial payment of 5000
indrayudha To iterate molloycm's BAII steps:

CFo=-5000 (the initial payment), press down
C01=-4000 (subsequent payments), press down
F01=10 (10 years), press NPV
I=10 (10%), press down to NPV
CPT