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Analyzing Options to Lease or Buy

1. For a high technology item, like computer equipment, is the lease option preferable from the very outset. Why or Why not?

2. Do factors like for example down payment and the security deposit that has to be paid-up front on an asset, have a major influence on a lease or loan option?

3. Under what circumstance is a capital lease a better alternative to an operating lease or buying an asset?

4. How do qualitative factors like the condition of an asset impact a final lease or buying decision?

5. How important are specialized asset leasing business to the success of innovative arrangements like a sale or a lease-back?

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Please see response attached, which is also presented below. I hope this helps and take care.

RESPONSE:

Interesting and somewhat complex questions, indeed. Let's take a closer look.

1. For a high technology item, like computer equipment, is the lease option preferable from the very outset. Why or Why not?

This is very situational and therefore, depends. Usually, the result of a lease versus buy analysis would determine the outcomes (i.e., whatever showed to more economical and practical procurement for the business). In other words, if leases versus buy analysis showed that lease was preferable from the outset, then that would be the way to go. If not, then buying a computer would be the way to go if it was shown to be more cost-efficient and practical for the business. Some business use a more informal manner of just asking themselves what seems more practical given their business situation. However, for larger corporations or someone who needs to account for finance allocation, then a lease versus buy analysis would be best. In fact, in the example to follow, the University has made this a part of policy and, thus, is mandatory prior to every purchase.

See http://66.102.7.104/search?q=cache:qwgW4eSPbP8J:www.scotiabank.com/images/en/filesbusiness/4814.pdf+How+important+are+specialized+asset+leasing+business+to+the+success+of+innovative+arrangements+like+a+sale+or+a+lease-back%3F+&hl=en

Let's look at an example, to understand the complexity and factors to consider in the decision making process:

Example:

Policy: When acquiring equipment, the University requires a lease versus buy analysis for all equipment costing $100,000 and greater, and recommends a lease versus buy analysis for all equipment costing less than $100,000, whether the expenditure is for an individual item or a bulk purchase.
Why have a lease versus buy analysis policy? As a public institution, the University must demonstrate prudent use of the funds entrusted to it by its various constituencies. This policy is designed to promote stewardship of the University's resources and to protect the interests of the University's funding sources. The Office of Management and Budget (OMB) Circular A-110 states that "Where appropriate, an analysis of lease and purchase alternatives should be made to determine which would be the most economical and practical procurement for the Federal Government." On sponsored projects, due to the impact of the indirect cost rate on the leasing alternative, the net present value of this option would normally be expected to be greater than the cost of an outright purchase. It is, however, the responsibility of the individual or department procuring the item to determine the most cost beneficial method.
(Source: http://www.fpd.finop.umn.edu/groups/ppd/documents/policy/lease_finance.cfm).

However, there are some rules of thumbs to consider when you decide to lease. Typically assets which have a long useful life (such as railcars, barges and the like) have relatively long lease terms (if the analysis showed this to be more cost efficient and practical), often ten years or more. At the other end of the scale, assets, which tend to become obsolete in a hurry (such as computers and almost anything "high tech") usually have lease terms of two to five years. Part of the difference in terms is driven by how long the lessee is likely to want to use the assets, without moving on to newer equipment or technologies. Part of the reason is also based on accounting issues, which limit the length of certain leases to no longer than 75% of their useful life. (Excerpt taken from article attached below, reference provided at end of article).

Ten Reasons to Lease... (exceprt)

We'd like to say that the most important reason is because Leasing Ideas wants your business, but that probably won't carry much weight with your Board of Directors. So here are ten other reasons which may be of interest...
#1 - Simplicity and Convenience
Once a master lease is in place, a lessee can often add equipment whenever, however and wherever they desire. Surveys have consistently ranked this as the most important benefit for lessees, which says something about the frustration levels that can result from dealing with budgets, bureaucracies and paperwork.
#2 - Preserving Liquidity
Leasing is often a zero down kind of financing and allows a firm to reserve their cash and borrowing power for operating expenses and other more intangible costs of doing business.
#3 - Cash Flow Management
In many cases, lease payments can be structured to match budgetary or cash flow requirements. If there is no space left in this year's budget, write a lease with no payments due until next year. If the revenues from the use of the equipment increase over time, write a stepped lease where the payments also increase over time. Payments can be made monthly, quarterly, semi-annually, annually, or any other way which works best for the lessee.
#4 - Lower Total Costs of Acquisition
The wild card here remains the residual issue, but in many cases, a properly structured lease will be significantly less expensive than acquiring the same equipment through outright purchase, particularly on an after tax basis.
#5 - Accounting Benefits
Just about any lease can be structured to meet the accounting tests for treatment as an "operating lease," thereby taking the lease obligation off the main balance sheet, which in turn can help by improving various financial ratios and performance indicators. In many cases, a lease will eliminate the possibility of a loss on sale when owned assets are eventually sold. If purchased and then depreciated, just about any high tech assets will be on the books at a value in excess of current market values.
#6 - Tax Benefits
Although each lease will differ, many companies will find the tax deductibility increased through leasing compared to ownership, particularly when dealing with high technology and other shorter-lived assets.
#7 - Outsourcing the Asset Management Headaches
Many firms choose to own those assets, which tend to appreciate in value (such as real estate) and lease those assets, which tend to depreciate in value (such as equipment). By partnering up with a qualified lessor who has real expertise in particular asset classes, a firm can leave the headache of getting rid of old technology to someone with the expertise and contacts to do so efficiently. If you build into the lease "cancel and return" options as well as early buy out and technology refresh options, you can maintain the flexibility to move to new equipment throughout the financing period rather than just at the end of the lease term.
#8 - Tracking Total Cost of Ownership
A lease makes things easier in terms of tracking costs relative to revenue produced; whether by product line, project, cost center or other indices. To help in this process, many leases will be written to include software, services, maintenance, training and other soft costs which are associated with the equipment itself, to cover all related costs under just one lease payment.
#9 - International Flexibility
A master lease written in the USA can often be adapted to allow for the equipment to be delivered and used anywhere in the world. Today's economy is increasingly global in nature; therefore the ability to easily finance in any country will soon be essential for business success.
#10 - Because Leasing Ideas Wants Your Business
Source: http://www.leasingideas.com/main/ten.html Retrieved August 14, 2005

2. Do factors like for example down payment and the security deposit that has to be paid-up front on an asset, have a major influence on a lease or loan option?

The same would apply to this question as to the first one. A lease versus loan analysis would consider ALL the financial cost factors of the item (i.e., down payment, ...

Solution Summary

This solution addresses several questions analyzing the option to buy or lease, and when or if one option is preferable over the other. For a high technology item, like computer equipment, for example, is the lease option preferable from the very outset. Why or Why not? Do factors like for example down payment and the security deposit that has to be paid-up front on an asset, have a major influence on a lease or loan option? Under what circumstance is a capital lease a better alternative to an operating lease or buying an asset? How do qualitative factors like the condition of an asset impact a final lease or buying decision? How important are specialized asset leasing business to the success of innovative arrangements like a sale or a leaseback?

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