Asked by TEDDY VELISSARIS on May 11, 2024
Verified
Air Atlantic (AA) has been offered a 3-year old jet airliner under a 12-year lease arrangement. The lease requires AA to make annual lease payments of $500,000 at the beginning of each of the next 12 years. Determine the present value of the lease payments if AA's cost of funds is 14 percent.
A) $2,830,000
B) $13,635,500
C) $6,000,000
D) $3,226,200
Lease Payments
Regular payments made by a lessee to a lessor for the use of an asset.
Cost of Funds
The interest rate that financial institutions pay for the use of money or funds they lend out to borrowers.
- Understand the concept of present value and how it is affected by interest rates and time.
- Differentiate between end-of-period and beginning-of-period payment scenarios and their impact on financial calculations.
Verified Answer
AA
Arianne AlipioMay 12, 2024
Final Answer :
D
Explanation :
The present value of the lease payments can be calculated using the formula for the present value of an annuity due, since payments are made at the beginning of each period. The formula for the present value of an annuity due is PV = PMT * [(1 - (1 + r)^-n) / r] * (1 + r), where PMT is the payment amount ($500,000), r is the interest rate per period (14% or 0.14), and n is the total number of payments (12). Plugging in the values, we get PV = $500,000 * [(1 - (1 + 0.14)^-12) / 0.14] * (1 + 0.14) = $3,226,200 approximately.
Learning Objectives
- Understand the concept of present value and how it is affected by interest rates and time.
- Differentiate between end-of-period and beginning-of-period payment scenarios and their impact on financial calculations.