Cerebral Corporation Started Operations on March I,2009

question 32

Essay

Cerebral 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).Cerebral's incremental borrowing rate is 5%.There is no bargain purchase or renewal option.Cerebral 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 5% 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 Cerebral for the first year of operations.Assume all payments were made when due.Show your calculations.

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Definitions:

Outstanding Shares

A corporation’s shares currently held by shareholders.

Articles of Incorporation

A paper submitted to the state authorities to formally set up a corporation.

Authorized Shares

The maximum number of shares that a corporation is legally permitted to issue, as specified in its charter.

Annual Dividend

The total dividend payment a company declares to distribute to its shareholders annually, often derived from the company's profits.