Rankin Ltd has entered into an agreement to lease an item of equipment that produces teddy bears. The terms of the lease are as follows:
- Date of entering lease: 1 July 2015.
- Duration of lease: 10 years.
- Life of leased asset: 10 years.
- There is no residual value.
- Lease payments: $5000 at lease inception, $5500 on 30 June each year (that is, 10payments).
- Included within the lease payments are executory costs of $500.
- Fair value of the machine at lease inception: $27470.
REQUIRED:
Determine the interest rate implicit in the lease.
Solution:
To undertake this calculation students may use trial and error. The implicit rate is 18%, proven as follows:
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Present value of initial payment
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$5000 x 1.0 =
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$5000
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Present value of yearly payments
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($5500 - $500) x 4.4941 =
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$22 470
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Fair value at lease inception
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$27 470
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