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Determine the interest rate implicit in the lease

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Reference no: EM131799875

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:

Present value of initial payment

$5000 x 1.0 =

$5000

Present value of yearly payments

($5500 - $500) x 4.4941 =

$22 470

Fair value at lease inception

 

$27 470

Reference no: EM131799875

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