According to “Lease Agreement” (2014), a lease is “a contract between a lessor and lessee that allows the lessee rights to the use of a property owned or managed by the lessor for a period of time. The agreement does not provide ownership rights to the lessee; however, the lessor may grant certain allowances to modify change or otherwise adapt the property to suit the needs of the lessee. During the lease period, the lessee is responsible for the condition of the property.” (“Lease Agreement”, 2014). According to “Buying vs. Leasing” (2014), Advantages of Leasing Equipment are less initial expenses. The primary advantage of leasing business equipment is that it allows you to acquire assets with minimal initial expenditures. Because equipment leases rarely require a down payment, you can obtain the goods you need without significantly affecting your cash flow. (“Buying vs. Leasing”, 2014). Leases are usually easier to obtain and have more flexible terms than loans for buying equipment. This can be a significant advantage if you have bad credit or need to negotiate a longer payment plan to lower your costs. (“Buying vs. Leasing”, 2014).
According to “Buying vs. Leasing” (2014), Leasing allows businesses to address the problem of obsolescence. If you use your lease to obtain items that may be outdated in a short period, such as computers or other high-tech equipment, a lease passes the burden of obsolescence onto the lessor. You are free to lease new, higher-end equipment after your lease expires. (“Buying vs. Leasing”, 2014). Another advantage of leasing equipment is that it can be tax deductible. Lease payments can usually be deducted as business expenses on your tax return, reducing the net cost of your lease. (“Buying Vs. Leasing”, 2014). Some of factors considered in deciding whether, or not to lease a asset or purchase the asset are the firms tax bracket, terms of lease, assets anticipated residual value, cost of obtaining funds to purchase the asset, life of the asset, how long the asset is needed, and the cost of maintaining the asset.
These the factors are combined to determine if the combined cash outflows for leasing the asset are more or less than the combined cash outflows and inflows of purchasing the asset. In our example, the present value of cash outflows from leasing the asset was less than the present value of cash outflows from purchasing the equipment so at least on paper it is the better way to go. Time value of money means that money received in the present is not valued the same as money received in the future it could increase if it compounds or decrease if it is discounted. In this example of evaluating whether it is better to lease or purchase the interest of the money borrowed to buy assets compounds increasing the total amount paid for the assets. In the example the given in the “Additional Problems With Answer” in the final pages of Ch. 27 of Basic Finance the money compounds increasing the future value of the money which directly increasing the amount of money that must be repaid to the financial institution that it was borrowed from.
Do to the present value of the cash outflows from owning exceed the present value of the cash outflow from leasing, leasing is preferred. The cost for maintenance and the depreciation value of the equipment is too much. The best decision is to lease the equipment. By the end of the 5th year, the asset will have lost 80 percent of its value. Since the company only plans to use it for three years it would be in the best interest of the company to lease the asset and save money on the maintenance and they asset would depreciate but that would not be an issue for the company but rather than of the leasing company. The company would be able to lease the asset at a less costly rate every year because of the depreciation.
Mayo, H. B. (2012). Basic finance: An introduction to financial institutions, investments, and management (10th ed.). Mason, OH: South-Western. Titman, S., Keown, A. J., & Martin, J. D. (2014). Financial management: Principles and applications (12th ed.). Upper Saddle River, NJ: Pearson/Prentice Hall.