Answer Happy

You have just been hired as the new controller of SWT Services Inc., and on the top of the stack of papers on your new desk is a bundle of draft contracts with a note attached. The note says, "Please help me to understand which of these leases would be best for our situation. The note is signed by the president of SWT Services Inc. You have reviewed the proposed contracts and asked a few questions. In the process, you have become aware that the company is facing a large cutback in capital spending to deal with competition in the industry. A new customer service system that is heavily IT-based is critical in meeting the challenge head on. The leases are for telecommunications and computer equipment and software. In order to meet this commitment, you need to identify the lease that will have the lowest total cost in the coming year and overall. As well, you will need to address the cash demands of each choice. The following information is available. Lease One: The equipment and software has a fair value of $488,827 and an expected life of six years. The lease has a five-year term. Annual rent is paid each January 1, beginning in 2020, in the amount of $104,500. The implicit rate of the lease is not known by SWT. Insurance and operating costs of $23,330 are to be paid directly by SWT to the lessor in addition to the lease payments. At the end of the lease term, the equipment will revert to the lessor, who will be able to sell it for $85,480. If the lessor is unable to sell the equipment for this amount, SWT will be required to make up the shortfall. SWT will likely purchase the equipment for $85.480 if any payments are required under this clause of the lease.

Lease Two: The equipment and software have a fair value of $451,810 and an expected life of seven years. The lease has a five-year term beginning January 1, 2020, with a two-year renewal period. Annual lease payments are made beginning December 31, 2020, in the amount of $138,800. This lease has an implicit rate of 8%. Insurance and operating costs of $25,930 are included in the lease payment. At the end of the initial lease term, the equipment can be leased for another two years for $26,880 per year, including insurance and operating costs. At the end of that two-year period, the equipment will belong to SWT. SWT follows IFRS 16 and has a December year end. SWT's incremental borrowing rate is 10% Click here to view the factor table PRESENT VALUE OF 1. Click here to view the factor table PRESENT VALUE OF AN ANNUITY DUE (b) Which lease do you recommend the company sign, assuming both will meet the company's requirements and the equipment proposed in both leases is similar? It is my recommendation that we sign