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Buying or Leasing a Computer System

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What is a lease? Why would you choose to lease a capital item versus buy? What steps would one follow to decide whether to lease or buy a computer system?

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What is a lease?

A lease is usually referred to as a rental agreement between the owner of the property commonly called the landlord or lessor and the renter of the property commonly called the tenant or lessee. The landlord gives the tenant the right to use and occupy rental property for a certain period of time. It can be an oral agreement or it can be in writing. Usually, if the lease extends beyond one year, states require it in writing. Oral lease has a disadvantage of future misunderstandings on the terms of the agreement. Potential problems for enforcement of the terms between the lessor and lessee can take place when the agreement is done orally. The use and possession of the rental property and other things that are part of the lease are to be returned to the landlord. The tenant also agrees to pay the landlord a specified amount of money each month which is called a rent. The agreement usually spells out all the terms involved in a land or merchandise rental agreement. This includes the length of time a lessee may use it and the conditions like financial penalties for late payments, schedule of payments and the condition of the property/properties upon return to the lessor. A lease can be short or long term. A short term lease can be extended for a number of years.

A lease agreement is a legally binding contract which obligates the renter to make regular payments and it protects both the lessor ...

Solution Summary

The solution discusses the definition of lease, the reasons why one would choose to lease a capital item versus buying and the steps one must follow to decide whether to lease or buy a computer system. This solution is 875 words.

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Lease vs Buy Decision for a new computer system

If purchased, a new computer system will cost $50,000 installed. The computer system has an estimated economic life of six years. Kinko's would depreciate the computer system as a 5 year asset under MACRS rules to a $0 estimated salvage value. If purchased, Kinko's could borrow the needed funds from PNC Bank at a 10 percent pretax annual percentage rate of interest.

If Kinko's decides to lease the computer system, it will be required to make six beginning of year lease payments of $11,000 each. Kinko's weighted cost of capital is 12 percent (after tax) Kinko's marginal tax rate is 40 percent.

Under both the lease alternative and the borrow and buy alternative, Kinko's will contract with a computer service company to handle the estimated annual service and maintenance costs.

If the computer system is owned and Kinko's borrows the needed funds from PNC in the form of a bullet loan carrying a 10 percent interest rate instead of an equal payment loan at 10 percent, what effect would this have on the decision to lease or buy?

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