Capital Versus Operating Lease
Hannah Steel Corporation signed a five year lease agreement on January 2, 2000,for the lease of equipment. The annual lease payment required at the end of each year is $4,000.The useful life of the equipment is five years and the fair market value is $18,000.
Required
a. Assume that Hannah’s (the lessee) incremental borrowing rate is eight percent. Calculate the present value of the lease payments.
b. Is this a capital lease or an operating lease?
c. If the lease payments are $4,000 per year, totaling $20,000, why isn’t $20,000 the present value of the lease?
d. Show the impact of this lease on Hannah’s balance sheet. (Hint: Use the accounting equation)
e. Advise Hannah on the advantages and disadvantages of a capital versus an operating lease.