Question

A person wants to lease out a machine costing ₹5,00,000 for a 10 year period. It has fixed a rental of ₹51,272 per annum payable annually starting from the end of first year. Suppose rate of interest is 10% per annum compounded annually on which money can be invested. To whom this agreement is favourable?

A. Favour of Lessee
B. Favour of Lessor
C. Not for both
D. Can't be determined

Answer 1

This agreement is favorable to the Lessee as they are paying less than the cost of the machine. Therefore correct option is A

Step-by-step explanation:

This agreement is favorable to the Lessee. To determine this, we need to calculate the present value of the annuity paid by the Lessee and compare it to the cost of the machine.

The present value of an annuity can be calculated using the formula: PV = A * [(1 - (1 + r)^-n) / r], where PV is the present value, A is the annuity payment, r is the interest rate, and n is the number of years. In this case, the annuity payment is ₹51,272, the interest rate is 10%, and the number of years is 10.

Plugging these values into the formula, we get:

• PV = ₹51,272 * [(1 - (1 + 0.10)^-10) / 0.10]
• PV = ₹51,272 * [(1 - (1.10)^-10) / 0.10]
• PV = ₹51,272 * [(1 - 0.3855) / 0.10]
• PV = ₹51,272 * [0.6145 / 0.10]
• PV = ₹51,272 * 6.145
• PV = ₹3,15,907.44

The present value of the annuity is ₹3,15,907.44, which is less than the cost of the machine (₹5,00,000). Therefore, the agreement is favorable to the Lessee, as they are paying less than the cost of the machine.