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CA Intermediate · Financial Management and Strategic Management · Types of Financing

Arjun Industries leases equipment on a finance lease. The lessor's cost of the asset is ₹3,00,000 and it expects to earn a rate of return that makes the annual lease rental ₹1,20,000 payable at the end of each of 3 years. Under the lessee's evaluation, the pre-tax cost of borrowing is 12% and the present value annuity factor for 3 years at 12% is 2.402. Ignoring tax and residual value, what is the present value of the lease rentals, and should the lessee prefer leasing over buying with a loan at 12% for the same ₹3,00,000 cost?

The present value of the rentals is ₹2,88,240, found by multiplying ₹1,20,000 by the 3-year, 12% annuity factor of 2.402. This is lower than the ₹3,00,000 purchase cost, so leasing is cheaper and is the preferable option in this evaluation.

  1. APV is ₹2,88,240; lease is preferable as PV is below ₹3,00,000Correct
  2. BPV is ₹3,60,000; lease is preferable as rentals exceed cost
  3. CPV is ₹2,88,240; buying is preferable as PV is below ₹3,00,000
  4. DPV is ₹3,00,000; both are equal

Explanation

PV of rentals = 1,20,000 × 2.402 = ₹2,88,240. Cost of buying is ₹3,00,000. Since PV of outflows under lease is lower, leasing is cheaper by ₹11,760. Option three reverses the decision; option two ignores discounting.

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