Exercise 6-20 Lease payments; solve for unknown interest rate [LO6-8, 6-9] On Ma

Question

Exercise 6-20 Lease payments; solve for unknown interest rate [LO6-8, 6-9] On March 31, 2016, Southwest Gas leased equipment from a supplier and agreed to pay $320,000 annually for 20 years beginning March 31, 2017. Generally accepted accounting principles require that a liability be recorded for this lease agreement for the present value of scheduled payments. Accordingly, at inception of the lease, Southwest recorded a $3,141,807 lease liability. (FV of $1. PV of $1. FVA of $1 PVA of $1. FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.) Required: Determine the interest rate implicit in the lease agreement Present value of lease n= Lease payments

Explanation / Answer

We can use the present value of annuity formula to calculate the interest rate implicit in the lease agreement. PV of annuity = P*{[1 - (1+r)^-n]/r} PV of annuity = present value of lease payments = $31,41,807 P = Annual lease payment = $320000 r = interest rate per annum = ? n = no.of years of lease payments = 20 3141807 = 320000*{[1 - (1+r)^-20]/r} 9.8181 = [1 - (1+r)^-20]/r r = 0.08 Interest rate implicit in the lease agreement = 8% Present value of lease payment $3,141,807 n 20 i 8% Lease payments $320,000

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