FIN370 Week4 Team DRAFT
Lease Versus Purchase
FIN/370
June 1, 2015
Karen De Michelis
Lease versus Purchase
Deciding to lease or purchase a home or car is one that every individual must consider. This decision is the same for businesses. The decision to lease or purchase for a business depends on several factors. Several questions should be asked to evaluate the decision. First, what is the company purchasing? What is the economic life of the purchase? How much depreciation of the item will occur over the period of the lease? What is the interest rate of the lease agreement? Will there be maintenance and repair costs associated with the lease/purchase? How does the decision to lease or purchase affect the company’s cash outflows?
Below is an analysis of the following scenario:
“Management has decided to acquire a new asset that costs $200,000. The estimated economic life of the asset is five years, but the firm wants the use of the asset only for three years. If the firm purchases the asset, it anticipates selling it at the end of three years for $50,000. The firm may lease the asset for $55,000 a year paid at the end of each year. The lease does not include maintenance. It is estimated that annual maintenance initially will be $5,000 (paid at the end of the year), but that cost will increase by $1,000 each year as the asset ages. The firm could purchase the asset with a five-year loan of $200,000. The loan will be retired in five payments of $40,000 unless the equipment is sold, in which case the loan must be paid off at closing of the sale. The interest rate is 10 percent and is paid at the end of each year on the balance owed. The annual interest payment is provided below. If the firm does purchase the asset, it will enter into a maintenance agreement with the manufacturer that costs $5,000 a year. The annual depreciation expense is provided below. The firm’s tax bracket is 40 percent. Based on the above information, should the firm borrow and purchase or should the
FIN/370
June 1, 2015
Karen De Michelis
Lease versus Purchase
Deciding to lease or purchase a home or car is one that every individual must consider. This decision is the same for businesses. The decision to lease or purchase for a business depends on several factors. Several questions should be asked to evaluate the decision. First, what is the company purchasing? What is the economic life of the purchase? How much depreciation of the item will occur over the period of the lease? What is the interest rate of the lease agreement? Will there be maintenance and repair costs associated with the lease/purchase? How does the decision to lease or purchase affect the company’s cash outflows?
Below is an analysis of the following scenario:
“Management has decided to acquire a new asset that costs $200,000. The estimated economic life of the asset is five years, but the firm wants the use of the asset only for three years. If the firm purchases the asset, it anticipates selling it at the end of three years for $50,000. The firm may lease the asset for $55,000 a year paid at the end of each year. The lease does not include maintenance. It is estimated that annual maintenance initially will be $5,000 (paid at the end of the year), but that cost will increase by $1,000 each year as the asset ages. The firm could purchase the asset with a five-year loan of $200,000. The loan will be retired in five payments of $40,000 unless the equipment is sold, in which case the loan must be paid off at closing of the sale. The interest rate is 10 percent and is paid at the end of each year on the balance owed. The annual interest payment is provided below. If the firm does purchase the asset, it will enter into a maintenance agreement with the manufacturer that costs $5,000 a year. The annual depreciation expense is provided below. The firm’s tax bracket is 40 percent. Based on the above information, should the firm borrow and purchase or should the
References: Business Equipment: Buying vs. Leasing. (2015). Retrieved from http://www.nolo.com/legal-encyclopedia/business-equipment-buying-vs-leasing-29714.html Mayo, H.B. (2012). Basic Finance. Retrieved from The University of Phoenix eBook Collection database.