Use the information in RE21-6. However, assume that there is no bargain purchase option and that Montevallo guarantees the $20,000 estimated residual value at the end of the 10-year lease. Calculate the present value of the minimum lease payments.
In RE21-6, Montevallo Corporation leased equipment from Folio Company. The lease term is 10 years, requires payments of $25,000 at the end of each year, and contains a bargain purchase option. At the end of the lease Montevallo has an option to pay $4,000 (which is much less than the estimated fair value at that time) to purchase the equipment. The equipment has a fair value at the inception of the lease of $175,000 and an estimated useful life of 20 years. The lease agreement stipulates that the Folio Company receive a rate of return of 8% each year, which is lower than Montevallo’s incremental borrowing rate. Calculate the present value of the minimum lease payments.