Kartik Corporation Started Operations on March I,2009

question 33

Essay

Kartik Corporation started operations on March I,2009.It needs to acquire a special piece of equipment for its manufacturing operations.It is evaluating two options as follows.
Option 1: Lease the equipment for 5 years.Lease payments would be $12,000 per year,due at the beginning of each fiscal year (March I).Kartik's incremental borrowing rate is 5%.There is no bargain purchase or renewal option.Kartik is responsible for all executory costs of operating the equipment.
Option 2: Purchase the equipment for $58,000 by borrowing the full purchase amount at 4% over 5 years.This price is considered the fair value of the equipment.Payments are due at the end of each fiscal year (February 28).
The equipment has a useful life of 5 years and would be depreciated on a straight-line basis.No residual value is expected to exist at the end of 5 years.
Requirements:
a.Calculate the present value of the lease payments (Option 1).
b.Calculate the payment that would be required under the purchase option (Option 2).
c.Calculate and briefly discuss the financial impact of each option on the non-current assets,total liabilities,and net income of Kartik for the first year of operations.Assume all payments were made when due.Show your calculations.

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Definitions:

Market Index

A statistical measure that represents the performance of a group of stocks, bonds, or other assets, serving as a benchmark to track financial and economic performance.

Forecasted Market Return

The estimated average return expected from the market as a whole over a specified future period, based on historical data and economic indicators.

T-Bill Rate

The yield on short-term U.S. government debt securities, known as Treasury bills, which serve as a benchmark for short-term interest rates.

Adjusted Beta

A beta value modified to account for a stock's historical volatility and tendency to revert to the market mean.