Lease Vs. Buy Decisions

Lease vs. Buy and the Impact on Capital Budgeting

Risks & Uncertainties:

• Purchase requires a significant cash outlay in the form of a down payment at the date of purchase.

• Purchasing equipment will add additional debt/liabilities on the balance sheet.

• Leasing minimizes the amount of cash paid initially to acquire the asset.

• With capitol leases, the depreciation can be claimed on the company’s balance sheet.

• The whole operating life of the object must be considered when deciding between purchasing and leasing.

o If the object will be used for its estimated operational life, than purchasing the object may be the best bet.

Computing Present Value (PV) of Outflows

Advantages in making Lease vs. Buy decisions:

• At the beginning of a lease, the present value of the lease payments is approximately 90% of the fair market value of the leased asset.

• The lessee is agreeing to pay almost as much as the cash value of the asset had they purchased it outright.

• The crucial issue has been how to require companies to report leased assets and lease liabilities in the balance sheet when a lease constitutes an effective transfer of ownership.

Simulation example:

• To lease or purchase equipment valued at $2,000,000. Based on our assessment of the situation and after analyzing the Present Value, the company was better off purchasing the equipment (40mo with $113608 down). The company would use the equipment for the entire life expectancy of the equipment. (See below for data analysis).

Rate= 15.00% 15.00% 15.00%

A Opp Lease B uy C apitol Lease

Init Invest at 0 $ (1,790) $ (2,224) $ (1,818)

1 $ 58,283 $ 113,608 $ 56,087

2 $ 5,828 $ 113,608 $ 5,609

3…. $ 5,828 $ 5,680 $ 5,609

40 $ 5,828 $ 5,680 $ 5,609

Sum of 1-40 $ 285,575 $ 443,056 $ 274,838

PV $ 84,321 $ 213,185 $ 81,148

Initial Investment $ (1,790) $ (2,224) $ (1,818)

NPV ($) $82,531 $210,961 $79,330

Profitability Index 4610.69% 9485.65% 4363.57%

IRR (%) 3166.316% 5106.48% 2995.39%

Capitol Lease vs. Operating Lease

Capitol