Colfax Corporation enters into an agreement with Reynolds Rentals on January 1,
ID: 2458626 • Letter: C
Question
Colfax Corporation enters into an agreement with Reynolds Rentals on January 1, 2014 for the purpose of leasing a machine to be used in its manufacturing operations. The term of the noncancelable lease is 5 years with no renewal option. Payments of $200,000 are due on December 31 of each year. The fair value of the machine on January 1, 2014, is $800,000. The machine has a remaining economic life of 10 years, with no salvage value. The machine reverts to the lessor upon termination of the lease. Colfax Corporation's incremental borrowing rate is 10% per year. Colfax does not have knowledge of the 8% implicit rate used by Reynolds. The factor for the present value of an ordinary annuity of 1, for 5 periods at 10% is 3. 79079. The factor for the present value of an ordinary annuity of 1, for 5 periods at 8% is 3. 99271. What type of lease is this from Colfax Corporation's point of view? Sales-type lease Direct-financing lease Capital lease Operating lease
Explanation / Answer
Answer: Capital Lease
A lease falls into the category of Capital lease if ,the present value of lease payments is greater than 90% of the asset's market value.
Since the present value of lease payments $758158 is greater than 90% of the asset's market value $720000. Hence this lease will be capital lease.
Fair Value of Machine $800,000 90% of Fair Value: (800000*90%) $720,000 Present Value of Lease Payments per Year $200,000 Present Value of $1 annuity at 10% for 5 Years $3.79079 Present Value of $200000 annuity at 10% for 5 Years $758,158