Lessor enters into an agreement with Lessee on January 1, 19A, for a 3-year rental of a machine. The machine has a 4-year life with a salvage value of $5,000 after 3 years and zero at the end of 4 years.
Lessor’s cost and selling price are both $25,000. Lessor’s interest rate is 8%; Lessee’s rate is 10%, and
Lessee is aware of Lessor’s rate.
Lessee has an option to purchase this machine after 3 years at a bargain price of $4,000. There are no uncertainties regarding costs or collections.
(a) What type of lease is this? Why?
(b) What interest rate should be used by Lessor? By Lessee?
(c) Calculate the annual rental.