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Lease Vs Buy / Depreciation

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Describe the effect interest rates have on the decision to lease vs. buy?

Give an example of the effect depreciation has on the decision to lease vs. buy? Why?

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Solution Summary

The effect of interest rates on the decision to lease vs. buy is explored.
An example of the effect of depreciation on the decision to lease vs. buy is given.

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Leasing versus buying

For many small businesses, leasing is a viable financing alternative to buying with a loan. Leasing may allow your young enterprise to conserve cash. It may also allow you to avoid buying equipment you may not want for long.

Companies routinely use leasing for some of their financing. Airlines lease their airplanes. Car-rental companies lease their fleets of rental vehicles. Most companies lease some or all of their office, warehousing, and retailing space.

A lease is a contract that obligates your business (the lessee) to make periodic payments to the lessor over the span of a lease term.

In the start-up or growth stage of your business, you may need to keep your cash expenditures as low as possible. You may also wish to avoid owning equipment in the early stages of your enterprise. Leasing helps your business to accomplish these goals.

Leasing services for businesses falls into two major categories:

Equipment leasing.
Equipment leasing finances everything from the manufacturing equipment to the personal computers, desks, and chairs used by you and your employees.

Real estate leasing.
Real estate leasing finances everything from office and retail space to warehouses and parking lots. Real estate leasing also includes sale-and-leasebacks. A sale-and-leaseback occurs when a company sells real estate and leases it back from the new owner.

The two major types of business leases are operating leases and capital leases:
Operating leases.
An operating lease is a lease that often allows the lessee to make smaller periodic payments than with a term loan. Smaller lease payments are the result of the lease not being fully amortized over the lease term. As a result, the leased equipment has a residual value at the end of the lease term.

An operating lease requires the lessor to service and maintain the equipment. Costs for these services are added to the lease payments. An operating lease also allows the lessee to cancel before the end of the lease term.

Capital leases.
A capital lease amortizes the lease over the span of the lease term. The lessee receives the tax benefits of a capital lease, such as the tax savings earned on the depreciation expense of the equipment. At the end of the lease term, the lessee owns the equipment or faces a much smaller residual value. Since capital leases are considered equivalent to loans, you are required to show any capital leases on your balance sheet.

Lease payments on a capital lease are larger than payments on an operating lease. In fact, capital-lease payments are comparable to loan payments. As a result, a lease-versus-buy analysis is more appropriate when evaluating operating leases.

While equipment leasing and real estate leasing have their respective unique terms (triple net in real estate leasing, for instance), operating leases have similar features, including:
Lower payments. Since ...

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