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I’m currently using the BPP Exam Kit for F2.
The following question has me confused:
JK leases an asset to LM on 1 January 20×1 under a five year finance lease. Lease installments of 100 000 are payable annually in advance commencing 1 Jan 20×1. The total expected residual value at the end of the lease term is 30 000 of which 25 000 is guaranteed. The interest rate is 8%.
What is the amount of the initial investment in the lease that the lessor should recognise at 1 Jan 20×1?
The answer is given as 351630, which they get by adding the PV of the installments (100000 x 3.312) the PV of the residual guarantee (25000 x 0.681) and the PV of the unguaranteed Residual Value (30000-25000 x 0.681).
My confusion is due to the addition of the guaranteed residual value. When calculating the gross investment in the lease do we not only add the unguaranteed residual value to the present value of the installments?
Thank you, sorry if its a bit long.
When the lease finishes the asset is returned to the lessor and they receive the value of the asset, guaranteed amount. The asset is worth more than this as there is also the unguaranteed amount that also needs discounting back to present value.