LEASE VS. BUY

Lease Vs. Buy



Lease Vs. Buy

Introduction

Buy or to lease, which one does a person choose? Many investors such as buyers or lessors across the world are asking every time they are requiring an asset or property. The answer is never easy, financial manager around the world have to answer these questions at every turn. By calculating the after tax outflows of both options, investors can determine which is more cost effective choice.

Discussion

Some tough questions may be asked before determining whether to lease or buy. This would allow the buyer or lessee to determine or require available options. (Brealey, R., Myers, S., & Marcus, A. 2004) A capital lease must meet one or more of the following criteria: (1) the lease transfers ownership of the property to the lessee by the end of the lease term. (2) The lease contains a bargain purchase option. (3) The lease term is equal to 75% or more of the estimated economic life of the leased property. However, if the beginning of the lease term falls within the last 25% of the total estimated economic life of the leased property, including earlier years of use, this criterion shall not be used for purposes of classifying the lease. (4) The present value of the minimum lease payments, excluding that portion of the payments representing execlutory costs such as insurance, maintenance, and taxes to be paid by the lessor, including any profit thereon, equals or exceeds 90% of the excess of the fair value of the leased property to the lessor. If the lease does not meet the criteria for classification as a capital lease, then it shall be classified as an operating lease. Capital leases are often better choices for equipment and operating leases are better for facilities. A capital lease is better than buying an asset when the value of the asset goes down rapidly and need to be upgraded frequently. Example: computer systems that need to be cutting edge in order for a company to be competitive. If a company needs to upgrade equipment frequently it only makes sense to lease the equipment. The logic behind this is as followed: If equipment need to be upgraded every 3 years and cost $50,000 a piece it would be best to lease it for the 3 years. Let's say that you bought the equipment and paid it off in 5 years, that's $10,000 per year plus interest. At the end of 3 years the company needed to upgrade so they try to sell it. They might have to sell it for very cheap or they'll have trouble selling it because the equipment is now out of date. After depreciation you ended up spending $40,000 dollars for 3 years use of the equipment. If the company leased it, they might have paid a little less than $10,000 a year but with out the head ache of having to turn the equipment back into liquid asset. In this scenario there's a slightly lower cost but a ...