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lease vs. buy decision

What risks and uncertainties should be considered while making a lease vs. buy decision? How do these risks and uncertainties impact capital budgeting?

What is the advantage of computing the present value of outflows in making lease vs. buy decisions?

In what circumstances is a capital lease a better alternative to an operating lease? Under what circumstances is a capital lease a better alternative than buying an asset?

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

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Hi there,

Here is some info for you regarding leasing vs buying:

Leasing Vs. Buying

The decision to acquire capital equipment, involves several issues. The first centers around the equipment itself - both in terms of specifications and sourcing. Once the decision has been reached as to what equipment will be purchased and from whom, the next major item becomes how it will be acquired.

When capital equipment, such as lift trucks, is being acquired, the basic decision to be made by management is ... should we own the equipment or should we lease it? There are advantages and disadvantages to each method, and therefore, careful thought needs to go into this decision. If the company elects to purchase equipment and assume ownership, they either pay for the equipment out of cash flow, bank lines of credit, or some other form of long term financing. If they choose to use the equipment rather than own it, they will enter into some form of lease arrangement with a leasing company. Typically, when this is done, the leasing company retains ownership of the equipment and establishes a fixed length long term rental with specified payments to the end user called the "Lessee".

Prior to the Tax Reform Act of 1986, the Federal Government created strong tax incentives toward the purchase of capital equipment. This incentive in the form of the Investment Tax Credit, had a strong influence on how companies acquired their equipment. The Tax Reform Act of 1986 eliminated the Investment Tax Credit and disincented through other means, equipment ownership for many companies. As a result, since the beginning of 1987, leasing has taken on a far more prominent role as a means of acquiring equipment. Leasing companies argue that the use of equipment - not the ownership is what allows for production and profitability. Some of the commonly cited advantages for leasing are conservation of capital, since most leased transactions involve 100% financing, flexibility of payment terms to reflect seasonality of a company's business or other trends, balance sheet cosmetics, sound equipment management, etc. These advantages to leasing are benefits only if they are applicable to a company's current situation and needs.

Equipment ownership has its advantages and disadvantages as does leasing. Historically, many companies have allowed finance and production to bump heads with one another. By this I mean that due to accounting or tax reasons, equipment was very often set up on the "books" at depreciable lives, far greater than the equipment's productive value. It is not hard to look around a plant and see old equipment that is absorbing a good deal of maintenance cost and has to stay into operation because it is still on the books for some value. Leasing very often mitigates this problem by structuring the lease to the optimum ...