Viribana Corporation Started Operations on March 1,2017

question 4

Essay

Viribana Corporation started operations on March 1,2017.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 10 years.Lease payments would be $11,200 per year,due at the beginning of each fiscal year (March 1).Viribana's incremental borrowing rate is 12%.There is no bargain purchase or renewal option.Viribana is responsible for all executory costs of operating the equipment.
Option 2: Purchase the equipment for $71,000 by borrowing the full purchase amount at 12% over 10 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 10 years and would be depreciated on a straight-line basis.No residual value is expected to exist at the end of 10 years.
Required:
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 Viribana for the first year of operations.Assume all payments were made when due.Show your calculations.
d.Indicate which option you would recommend for Viribana.Provide one explanation to support your recommendation.

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Definitions:

Partial Equity Method

A variation of the equity method in accounting, where the investor recognises income from the investee to the extent of dividends received, with some adjustments.

Initial Value Method

An accounting method which records assets and investments at their original purchase cost.

Lower-of-Cost-or-Market-Value

An accounting principle requiring that inventory be recorded at the lower of either its historical cost or its current market value.

Book Value

The value of an asset as reported on a company's balance sheet, calculated as the cost of the asset minus any accumulated depreciation.