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

Arjun Ltd. plans to buy a machine costing Rs 5,00,000 on finance lease. Lease rental is Rs 1,40,000 per year for 5 years, payable at year-end. The lessor's implicit rate is 12%. Present value annuity factor for 5 years at 12% is 3.605. The lessee's alternative is a loan at 12%. Ignoring tax, what is the net advantage or disadvantage of leasing (PV of rentals vs cost)?

Leasing shows a net disadvantage of Rs 4,700. The present value of rentals is Rs 1,40,000 x 3.605 = Rs 5,04,700, which exceeds the purchase cost of Rs 5,00,000 when discounted at 12%, so buying is slightly cheaper ignoring tax.

  1. ADisadvantage of Rs 4,700 (PV of rentals Rs 5,04,700)Correct
  2. BAdvantage of Rs 4,700
  3. CAdvantage of Rs 1,95,000
  4. DDisadvantage of Rs 2,00,000

Explanation

PV of rentals = 1,40,000 x 3.605 = Rs 5,04,700. Cost of buying = Rs 5,00,000. Leasing costs Rs 4,700 more in present value terms, so it is a disadvantage. Option B reverses the sign. Option D just compares total undiscounted rentals (7,00,000) with cost.

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