Question
Sunland Corporation is a diversified public company with nationwide interests in commercial real estate development, banking, copper mining, and metal fabrication. The company has offices
Sunland Corporation is a diversified public company with nationwide interests in commercial real estate development, banking, copper mining, and metal fabrication. The company has offices and operating locations in major cities throughout Canada. With corporate headquarters located in a metropolitan area of a western province, company executives must travel extensively to stay connected with the various phases of operations. In order to make business travel more efficient to areas that are not adequately served by commercial airlines, corporate management is currently evaluating the feasibility of acquiring a business aircraft that can be used by Sunland executives. Proposals for either leasing or purchasing a suitable aircraft have been analyzed, and the leasing proposal was considered more desirable.
The proposed lease agreement involves a twin-engine turboprop Viking that has a fair value of $1.68 million. This plane would be leased for a period of 10 years, beginning January 1, 2017. The lease agreement is cancellable only upon accidental destruction of the plane. An annual lease payment of $191,289 is due on January 1 of each year, with the first payment to be made on January 1, 2017. Maintenance operations are strictly scheduled by the lessor, and Sunland will pay for these services directly to suppliers as they are performed. Estimated annual repair and maintenance costs are $41,328. Sunland will pay all insurance premiums, which amount to a combined total of $38,080 annually, and provide proof of coverage to the lessor. Upon expiration of the 10-year lease, Sunland can purchase the Viking for $336,000. The plane's estimated useful life is 15 years, and its value in the used plane market is estimated to be $448,000 after 10 years. The residual value will never be less than $308,000 because of the mandated engine overhauls and the maintenance prescribed by the manufacturer. If the purchase option is not exercised, possession of the plane will revert to the lessor; there is no provision for renewing the lease agreement beyond its termination on January 1, 2027.
Sunland can borrow $1.68 million under a 10-year term loan agreement at an annual interest rate of 10%. The lessor's implicit interest rate is not expressly stated in the lease agreement, but this rate appears to be approximately 6% based on 10 net rental payments of $191,289 per year and the initial fair value of $1.68 million for the plane. On January 1, 2017, the present value of all net rental payments and the purchase option of $336,000 is $1,422,469 using the 10% interest rate. The present value of all net rental payments and the $336,000 purchase option on January 1, 2017 is $1.68 million using the 6% interest rate implicit in the lease agreement. The financial vice-president of Sunland Corporation has established that this lease agreement is a financing lease as defined by the IAS 17 standards followed by Sunland.
Using factor tables, a financial calculator, or Excel functions, recalculate the present value of the future minimum lease payments and prove the amount arrived at by the vice-president of Sunland Corporation.
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