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Chapter 6

Actuarial method

Here the implied interest rate is found by using an IRR approach.

As a short cut, the 4 year annuity factor at the IRR can be found by dividing the
cost of the asset by the annual interest payment (i.e. 100,000/29,500). This gives
a 4 year annuity factor of 3.390, which (from tables) is very close to the 7%
factor. Hence, the implied interest rate in the lease is (approximately) 7%.

Now, the interest can be allocated to individual years using the following table:

USD Year 1 Year 2 Year 3 Year 4
Opening balance 100,000 77,500 53,425 27,665
+ Interest (7%) 7,000 5,425 3,740 1,937
– Payment (29,500) (29,500) (29,500) (29,500)
Closing balance 77,500 53,425 27,665 102
Note: The closing balance at the end of year 4 should be zero. The difference is
due to rounding.

The lease interest payments have now been allocated to years, so can be used
to calculate the tax relief each year.

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