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CMA Final · Strategic Financial Management · Leasing Decisions

Sharma Textiles Ltd leases a machine for 5 years at an annual rental of Rs 3,00,000 payable at the end of each year. The lessor's cost of the machine is Rs 11,37,000 with no residual value expected. Ignoring tax, the lessor's implicit rate of return is the rate that equates the present value of rentals to the cost. Using a present value annuity factor of 3.79 for 5 years at 10%, what is the lessor's implicit rate and is it consistent with the data?

The lessor's implicit rate is 10%. Present value of the rentals, Rs 3,00,000 multiplied by the 5-year annuity factor of 3.79 at 10%, equals Rs 11,37,000, which is exactly the machine's cost. Hence the rate that equates rentals to cost is 10%.

  1. A10%, since 3,00,000 x 3.79 = 11,37,000Correct
  2. B12%, since rentals total Rs 15,00,000
  3. C8%, since the cost exceeds the rentals
  4. D15%, since the lease is for 5 years

Explanation

The implicit rate satisfies cost = rental x annuity factor. 3,00,000 x 3.79 = 11,37,000, which equals the cost exactly, so the rate is 10%. The other options use unrelated reasoning such as total rentals or lease term, not the present value equation.

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