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CMA Intermediate · Financial Management and Business Data Analytics · Financial Institutions

A leasing company, Kaveri Leasing, buys equipment for Rs 10,00,000 and leases it for 5 years at an annual rental of Rs 2,63,797 payable at the end of each year, with no residual value. Annuity factor at 10% for 5 years is 3.7908. If the lessor's required return is 10%, what is the approximate NPV of the lease to the lessor, ignoring tax?

The NPV is approximately zero. The present value of five year-end rentals of Rs 2,63,797 at 10% is about Rs 10,00,000 (rental times 3.7908), which equals the equipment cost. The lessor therefore earns exactly its 10% required return, so the lease neither adds nor destroys value.

  1. ARs 1,63,797
  2. BRs 3,15,000
  3. CRs 0 (approximately)Correct
  4. DRs (1,00,000)

Explanation

PV of rentals = 2,63,797 x 3.7908 = about Rs 10,00,000. Less cost Rs 10,00,000 gives NPV of about zero, so the 10% rate is the lease's implicit return. Rs 1,63,797 wrongly takes one year's rental minus cost style difference, and the others ignore discounting.

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