Question 4

Johnson Ltd has entered into a lease arrangement with ABC Ltd in which it has agreed to lease an item of machinery from ABC Ltd on the following terms:

Date of commencement of lease: 1 July 2015

Duration of lease: 8 years

Fair value of machine at lease inception: $871172

Initial up-front payment: $200000

Lease payments at the end of each year: $100000

Implicit rate of interest: 6%

The lease is considered to be non-cancellable. The economic life of the machinery is considered to be 10 years. However, Johnson Ltd will return the machinery to ABC Ltd at the end of the lease term. At this stage it is expected that the machinery will have a residual(unguaranteed)value of $80000 at the end of the lease term.

Required:

1. Determine the present value of the minimum lease payments.
2. prove that the rate of interest implicit in the lease is 6%.