The Irish Inn is contemplating the purchase or lease of a new dryer. Tip 'Reilly, 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:

Estimated life of dryer:

Average cost of debt:

Incremental cost of debt:

Lease payments due:

-first payment due at signing (January 1, 20X1)

-next five payments annually beginning

January 1, 20X2

Annual lease payment: $1,000

First lease payment: $1,000

Fair market value: $4,500

There is also no option to buy at the end of lease; the dryer reverts to lessor at the end of

the lease period.

Required:

1. Is the owner correct in his belief that the lease would not be capitalized? Show all your

work in arriving at your decision.

2. What is the present value of the lease payment stream?

3. Prepare the journal entry to record the lease assuming it will be capitalized.

4. What is the amount of interest for 20X1?

5. What is the amount of interest over the life of the lease (20X1-20X5)?