How does the time value of money influence the choice between upfront payment and installment payments in a finance lease?

• A. Money now is worth less, so installments are always better.
• B. Because money now is worth more, upfront payments may reduce overall cost when appropriate.
• C. The time value is irrelevant to such decisions.
• D. Interest rates do not affect present value calculations.

Answer: (B)

Time value of money means a dollar today is worth more than a dollar tomorrow because it can earn interest. In a finance lease, you compare the cost of paying all at once to the present value of a stream of lease payments.

Paying upfront converts future payments into a single immediate outlay and often eliminates the interest portion embedded in those payments. When you discount the future installments back to present value at the lease’s implicit rate (or your opportunity rate), the upfront payment can yield a lower total present-value cost if the saved financing charges exceed any benefit you’d gain by keeping the cash invested elsewhere. In short, money now is more valuable, so an upfront payment can reduce overall cost when it’s the better use of funds relative to the lease rate.

If your cash could earn more by investing elsewhere, you might prefer to finance and keep the cash, since that would allow you to earn a return greater than the implied cost of the lease. The other statements ignore that interest and discounting change how much future payments are really worth today.