The Irish Inn is contemplating the purchase or the lease of a new dryer. Tip O’Donnell, owner of the Irish Inn, believes that the lease would not be capitalized and thus his financial ratios would not be adversely affected by the lease.

He has asked you to examine the proposed arrangement, which is as follows:

Term of lease 5 years Estimated life of dryer 8 years Incremental cost of borrowing 12%

Lease payments due:

First payment due at signing of lease (January 1, 20X1)

Next four payments annually beginning at January 1, 20X2 Annual lease payment amounts $1,500 First lease payment amount $1,000 Fair market value $4,500 Option to buy at the end of lease No Will the dryer be given to the lessee at the end of the lease term? No Required:

1. Determine the present value of the lease payment stream.

2. Should the lease be capitalized? Why or why not?