Question

a. In 2009, XYZ Enterprises negotiated and closed a long-term lease contract for newly constructed truck terminals and freight storage facilities. The buildings were constructed on land owned by the company. On January 1, 2010, XYZ took possession of the leased property. 20-year lease is effective for the period January 1, 2010, through December 31, 2029. Advance rental payments of $800,000 are payable to the lessor (owner of facilities) on January 1 of each of the first 10 years of the lease term. Advance payments of $400,000 are due on January 1 for each of the last 10 years of the lease term. XYZ has an option to purchase all the leased facilities for $1 on December 31, 2029. At the time the lease was negotiated, the fair market value of the truck terminals and freight storage facilities was approximately $7,200,000. If the company had borrowed the money to purchase the facilities, it would have had to pay 10% interest. Should the company have purchased rather than leased the facilities?

Answer 1

XYZ Enterprises should lease the newly constructed truck terminals and freight storage facilities instead of purchasing them.

How is the lease cost calculated?

The lease cost can be calculated by finding the present value of the annual lease payments.

The present value of the annual lease payments represents the discounted value of the future cash outflows.

The PV annuity factor can be used to compute the total lease cost in present value, as follows:

Data and Calculations:

Lease Option:

Interest rate = 10%

Lease period = 20 years

                                                               Lease     PV Annuity Factor    PV

Annual lease cost for 1st 10 years     $800,000     6.145             $4,916,000

Annual lease cost for 20 years         $400,000     8.514            $3,405,600

Less Annual lease cost 2nd 10 years 400,000     6.145             (2,458,000)

Total Present Value of Lease Cost =                                          $5,863,600

Purchase Option:

Fair market value = $7,200,000

Given the present values of the two options, XYZ Enterprises is advised to lease instead of purchasing the facilities.

Learn more about comparing lease and purchase options at https://brainly.com/question/23437834

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