Smith Co. has a machine that cost $200,000. It is to be leased for 20
years with rent received at the beginning of each year. Smith wants a
return of 10%. Calculate the amount of the annual rent.

Period: 19 Present value of ordinary annuity: 8.36492
Period: 20 Present value of ordinary annuity: 8.51356
Period: 21 Present value of ordinary annuity: 8.64869

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Request for Question Clarification by omnivorous-ga on 27 Nov 2006 07:17 PST

Steph --

There are a couple of problems with this question as stated:
*  Smith Co. would normally depreciate the equipment, changing cash
flow from income taxes
*  the problem makes it appear as if the company is borrowing at 0%,
which is unlikely.  Are you trying to calculate a gross return of 10%
on $200,000 -- or a real rate of return based on some cost of capital?

Best regards,

Omnivorous-GA

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Clarification of Question by steph21480-ga on 27 Nov 2006 07:46 PST

Hi there! The assumption is that the equipment was paid cash, and what
I?m trying to determine is the annual rent in order to produce a 10%
return on the $200,000 investment. Does that make sense?

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Request for Question Clarification by omnivorous-ga on 27 Nov 2006 08:01 PST

Steph --

Actually it doesn't make sense because we have no cost of money.  As
it is stated, Smith Co. could simply price the lease at $11,000 per
year to get $220,000 over the period of the equipment life.

But that ignores cost-of-money (which an NPV factor takes into account).  

It also ignores taxes, which are important in equipment leasing.  I
recognize that may be outside the scope of this question but you'll
certainly need a cost-of-capital rate for Smith Co.

Best regards,

O.