A company may obtain a machine either by leasing it for 5 years, (useful life) at an annual rent of Rs.2,000 or by purchasing it for Rs. 8,100. If the company can borrow money at 10% p.a. which alternative is preferable?
Answers
Given : A company may obtain a machine either by leasing it for 5 years, (useful life) at an annual rent of Rs.2,000 or by purchasing it for Rs. 8,100. If the company can borrow money at 10% p.a.
To find : which alternative is preferable
Solution:
Consider it like purchasing it for Rs. 8,100
and 2000 as down Payment & Then paying 4 EMI
if EAI is more than 2000 then leasing is good deal
if EAI is less than 2000 then its a borrowing at 10 % is good deal
EAI = Equal annual installments
EAI = EAI Formula = [P x (R/100) x (1+(R/100)ⁿ]/[(1+(R/100)ⁿ-1]
P = 8100 - 2000 = Rs 6100
R = 10 % per annum =
n = 4
EAI = 6100 * (10/100) * (1 + 10/100)⁴ / ( (1+ 10/100)⁴ - 1)
=> EAI = 610 * 1.1⁴ /(1.1⁴ - 1)
=> EAI = 1,924.37
1,924.37 < 2000
borrow money at 10% p.a. is better alternative
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