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

Kaveri Ltd. is considering leasing equipment costing Rs 10,00,000 versus borrowing at 10% p.a. The lessor will charge annual lease rentals of Rs 2,64,000 (payable at the end of each year) for 5 years. Ignoring tax and residual value, the PV annuity factor at 10% for 5 years is 3.7908. What is the present value of lease rentals, and which option is cheaper?

The present value of the rentals is 2,64,000 multiplied by 3.7908, about Rs 10,00,771. This is higher than the Rs 10,00,000 cost of buying with a 10% loan, so borrowing and buying is marginally cheaper than leasing.

  1. ARs 10,00,771; borrowing is cheaperCorrect
  2. BRs 10,00,771; leasing is cheaper
  3. CRs 13,20,000; leasing is cheaper
  4. DRs 9,50,000; leasing is cheaper

Explanation

PV of rentals = 2,64,000 x 3.7908 = Rs 10,00,771 (approx.). This exceeds the purchase cost of Rs 10,00,000 by about Rs 771, so leasing costs slightly more in present value terms and borrowing to buy is cheaper. Rs 13,20,000 is merely the undiscounted sum of rentals.

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