CMA Final · Strategic Financial Management · Leasing Decisions
Kaveri Ltd can buy equipment for Rs 5,00,000 or lease it at Rs 1,40,000 per year for 4 years, payable at the end of each year. Tax rate is 30%; the lease rental is fully deductible. Ignore depreciation and salvage. Discount rate after tax is 10% (PVIFA 10%, 4 years = 3.170). What is the present value of the after-tax cost of leasing?
The present value of the after-tax lease cost is Rs 3,10,660. The rental of Rs 1,40,000 falls to Rs 98,000 after a 30% tax saving, and discounting this at the 4-year annuity factor of 3.170 gives the result. Ignoring the tax shield gives Rs 4,43,800.
- ARs 4,43,800
- BRs 3,10,660Correct
- CRs 5,00,000
- DRs 1,86,000
Explanation
After-tax rental = 1,40,000 x 0.70 = 98,000. PV = 98,000 x 3.170 = Rs 3,10,660. Rs 4,43,800 is the pre-tax rental PV (1,40,000 x 3.170), missing the tax shield.
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