### CFA Practice Question

There are 520 practice questions for this study session.

### CFA Practice Question

On December 31, Acadia Corp. leased machinery with a fair value of \$420,000 from Clive Leasing. The agreement is a six-year non-cancelable lease requiring annual payments of \$80,000 beginning December 31 of that year. The lease is appropriately accounted for by Acadia as a capital lease. Acadia's incremental borrowing rate is 11%. Acadia knows the interest rate implicit in the lease payments is 10%.

The present value of an annuity due for 1 of 6 years at 10% is 4.7908.
The present value of an annuity due for 1 of 6 years at 11% is 4.6959.

In its December 31 (same year) balance sheet, Acadia should report a lease liability of ______.
A. \$303,264
B. \$375,672
C. \$383,264
Explanation: The liability is the present value of the payments due. (\$80,000 x 4.7908) - \$80,000 = \$303,264

User Comment
kalps Less £80k becos that is paid in year 1 and does not accrue interest and is not a liability. However, surely it is a prepayment as it should relate to the following year as the use for the rent does not start from next year - slightly confusing question
shasha again, for annuity due, deduct \$80,000 from pv (4.7908*\$80,000) to get the beginning lease liability of \$303,264.
adam08 chamad: use the interest rate implicit in the lease payments, which is 10%.
chamad why 10% instead of 11%. And since the annuity is alreday due why deduct 80k? someone please?
lavalyn The interest rate to use is 10%, because that is the implicit interest rate as stated. The marginal borrowing rate is irrelevant.

The first payment of the annuity is already *paid* at the end of December 31st. So we deduct the \$80k.
migena The questions states:
The present value of an annuity due of 1 for 6 years at 10% is 4.7908.
The present value of an annuity due of 1 for 6 years at 11% is 4.6959.

PMT/(1+r)n = PV of anunuity ....i am confused about the PV figures given in the question??!!
uma85 A lessee must capitalize if the PV (i.e. the discount rate used is LOWER of lessee's incremental borrowing rate or rate implicit in the lease) of the minimum lease payments is 90 % or more of the assets fair market value.
dlukas migena, your formula is the only the PV of a cash flow occurring in period n. Forget formulas; use your calculator.
teje n=5
I-rate= 10%
pmt = 80,000

PV = 303,264
dipu617 Thanks teje...
StJohnDale Implicit interest rate of the lease sets the lease payments equal to the assets fair market value - as such we should use the implicit interest rate
schweitzdm Why is teje using n=5?
BladeMage3 Consider the cash flows of this lease:
5 payments
CF0 = 80,000
CF 1-5 = 80,000
Total cashflows = 480,000
Net Present Value = 383,262.9 at lease inception
The first payment is made upon inception of the lease, so the net liability to be recorded is 383,262.9 - 80,000 = 303,262.9
daddyS9107 The CFA book clearly says: "The initial value of both the leased asset and lease payable is the LOWER of the PRESENT VALUE of future lease payments and the fair value of leased asset". The present value of future lease payments is less than 420.000 since discount rate is 11%, not the 10% implicit in the 420.000. Don't understand at all we everyone agrees
daddyS9107 Therefore the discount rate used should be 11% since it gives the lower of the present values
Lambo83 Can anyone explain why the present value of the annuity due at 10% is 4.7908?
rjdelong Lease Liability = PV (Payments still owed)
1st payment is made so not owed
Remaining 5 payments will come at END of the next 5 years

5 CF of 80k at END of period discounted at 10%

N=5,
I/Y = 10,
PMT = 80,000
--> CPT PV = 303,264

- OR -

Imagine the payment is not made yet

BGN mode
N=6,
I/Y = 10,
PMT = 80,000
--> CPT PV = 383,264

PV of the lease BEFORE they make a payment so then you just subtract the payment of 80,000 and you have the