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Time Value of Money

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Question : 71 of 99

Marks: +1, -0

A company is considering proposal of purchasing a machine either by making full payment of Rs. 4000 or by leasing it for four years at an annual rate of Rs. 1250. Which course of action is preferable if the company can borrow money at

14\%

compounded annually?

[ P(4,0.14)=2.9137 ]

leasing is not preferable
leasing is preferable
cannot determined
none of these

Solution:

Concept:

Compare the present value cost of leasing with the outright purchase cost.

Explanation:

Outright purchase cost: Rs. 4000 (paid now).

Leasing: annual payment Rs. 1250 for 4 years at 14% compounded annually.

Given present value annuity factor

P(4,0.14) = 2.9137

.

Present value of lease payments =

1250 \times 2.9137 = 3642.125

.

Since

3642.125 < 4000

, leasing is cheaper in present value terms.

Answer:

Leasing is preferable.

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