Ford Motor Company (Ford) needs to acquire computer equipment from IBM as of January 1, Year 4. Ford can borrow the necessary funds to purchase the computer for $10,000,000. Ford, however, desires to keep debt off its balance sheet and to structure an operating lease with IBM. The computer has an estimated life to IBM of five years. Ford will lease the computer for three years, at which time the computer reverts back to IBM. The cost to IBM to manufacture the computer is $8,000,000. Ford's borrowing rate for three-year secured financing is 8 percent.
a. Assume that Ford must make rental payments on December 31 of Year 4 through December 31 of Year 6. What is the maximum annual rental (to the nearest dollar) that Ford can make and still permit this lease to qualify as an operating lease?
b. Assume that Ford must make rental payments on January 1, Year 4, through January 1, Year 6. What is the maximum annual rental (to the nearest dollar) that Ford can make and still permit this lease to qualify as an operating lease?
c. Assume for the remaining parts of this problem that Ford will make annual payments of $3,880,335 on December 31, Year 4, through December 31, Year 6. Indicate the nature and amount of revenues and expenses (excluding income taxes) each company would report for each of the Years 4 through 6, assuming that they accounted for the lease as an operating lease.
d. Repeat part c, assuming that each company accounted for the lease as a capital lease.
e. Assume that these firms treat the lease as a capital lease for financial reporting and an operating lease for tax reporting. Compute the amount of deferred tax asset or deferred tax liability each firm would report related to the lease on December 31, Year 4, through December 31, Year 6. The income tax rate is 35 percent.