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

Kaveri Ltd needs a machine costing ₹10,00,000. It can take it on finance lease for 5 annual rentals of ₹2,60,000 paid at the end of each year, with nil residual value. Alternatively it borrows at 10% and buys. The 10% annuity factor for 5 years is 3.791. The firm ignores tax. Which statement is correct?

Leasing is better. The present value of five rentals of ₹2,60,000 at 10 percent is 2,60,000 × 3.791 = ₹9,85,660, which is less than the ₹10,00,000 purchase cost, so the lease has a lower present cost by ₹14,340.

  1. ALeasing is better because PV of rentals is ₹9,85,660, below ₹10,00,000Correct
  2. BBuying is better because PV of rentals is ₹10,50,000
  3. CBoth are equal because rentals total ₹13,00,000
  4. DLeasing is better because PV of rentals is ₹7,58,200

Explanation

PV of rentals = 2,60,000 × 3.791 = ₹9,85,660. Purchase outflow is ₹10,00,000 today. Since PV of lease payments is lower by ₹14,340, leasing is cheaper. Option B uses an incorrect PV, and D uses a wrong rental of ₹2,00,000.

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