GE Transportation plans to replace their computer equipment for the Human Resources and recruitment department having roughly 100 employees. This paper is based on researching what is the most economical way for the employer, GE, to outfit its office with computer. In this paper the pros and cons both of buying new equipment for the employees or leasing computers to use are analyzed. As per the results of the research, it was found that it is in the best interest of GE transportation to lease the computer equipment. Purchasing computer equipment will cost U.S. $88,461 and will have limited coverage for repairs. Renting computer equipment will cost 80,793 and will also come with a service contract for $500 annually.
Comparing Leasing vs. Purchasing Computer Equipment?
In a meeting on March 19th, 2013 Kerry Hamilton of GE Transportation requested Julia Clukey to research the available options for replacing the department's computer equipment. The two viable options were buying new computer equipment from Lenovo or leasing equipment from a local company.
Leasing computer equipment is the most economical way to outfit GE's Human Resource Department with new computers.
In this study, we will evaluate the most feasible method of acquiring IT equipment for GE Transportation. The advantages and disadvantages of leasing or purchasing the equipment are highlighted and evaluated in this paper. And we believe that this paper would be beneficial for every business owner and financial manager.
Leasing has many advantages; the leasing firm has acquired considerable knowledge about the kinds of equipment it leases. Thus, it can provide expert technical advice based on experience with the leased equipment.
Furthermore, another important advantage of leasing is that in the event of bankruptcy, the claims of the lessor to the assets of a firm are more restricted than those of general creditors.
While the most cost-effective alternative is preferred, non-financial factors such as obsolescence and associated risks also need to be considered as a part of the lease vs. buy decision.
For businesses, capital-leasing property may have significant financial benefits:
1. Leasing is less capital-intensive than purchasing, so if a business has constraints on its capital, it can grow more rapidly by leasing property than it could by purchasing the property outright. A major benefit that is being provided by leasing is that it allows a company to save its capital for investment in various business projects rather than investment in the equipment and infrastructure that is being required to run the business. In addition to that, unlike other methods of financing, leasing does not require any commitment fee or down payment. Leasing can be beneficial in relation to liquidity purposes as it allows the cash of the organization to be invested in liquid assets rather than hard assets. (Alexander, P.)
2. Capital assets may fluctuate in value, therefore, leasing is more beneficial as it shifts risks to the lessor. Through leasing the lessee can transfer the residual value risk to the lessor because the value of their acquisition is less than that of the lessor. In addition to that, the lessor also provides the lessee with an orderly disposal service and due to this service the lessee does not have to consider various unpredictable costs of disposal of the equipment at the end of the lease period. The lessor is responsible for the collection, disposal, discharge or resale of the equipment. All the preceding functions are performed by using the procedures that are in alignment with the laws of environment. These terms can be included in the lease agreement at the beginning of the lease period so that no negotiations are to be performed at the end of the lease period. (Gail Group)
3. Leasing may provide more flexibility to a business which expects to grow or move in a relatively short-term, because a lessee is not usually obliged to renew a lease at the end of its term. Leasing allows the lessee to take full use of the modern technology. Leasing permits the customers to move up on the technology curve as it enables them to use the technology upgrades whenever their business requires. This is an attractive option for the business that project short-term growth. In addition to that, some leases come with an upgrade option that allows the organizations to upgrade their existing technology as per the requirements of the business without even waiting for the lease period to end. (Schwartz, J.)
4. When controlling cash flow is critical and you don't have time to worry about your equipment, leasing can be a great option. Lease payments are designed in a way that they fit the cash flow and other financial requirements of the lessee. The lessee can design the payments according to his terms and conditions. In our case we can decide to pay less at the start and more at the end of the period. Or we can also make a payment schedule which is in alignment with our seasonal revenues. (Roch, 2005)
5. If the obsolescence risk is high, then the lease will be preferable. In our case the obsolescence risk is very high as the life cycle of technology can be as short as two to three years. Leasing allows the organizations to take full use of the life of the technology as it can be matched with the terms of the lease. Use of new technology improves the performance of the organization and has a positive impact on the price/performance curve of the organization. Organizations cannot remain competitive while waiting for their depreciation cycle to be completed as it is a necessary requirement for the disposal or replacement of the obsolete equipment. Hence in the case of technological equipment leasing is a very attractive option. (Roch, 2005)
6. Lease requires no restriction on a company's financial operations, while loans often do; a loan usually involves some restrictive conditions and if the borrower does not adhere to these conditions then this may result in default whereas, a lease does not have any such conditions therefore, it does not threaten the decision making authority and independence of the lessee. ("There are some," )
7. Lease spreads payments over a longer period (which means they'll be lower) than loans permit; the loans are usually based on floating rates therefore the payment schedule of the loan changes with the change in the market which makes prediction of cash flows very difficult. In addition to that, if the loans are not issued on fixed rate financing, then the payment schedule of loans is usually based on the type of the equipment rather than the use, economic life and obsolescence of the equipment. Lease on the other hand prepares a payment schedule based on the use, economic life and obsolescence of the equipment rather than its type. ("There are some," )
2.1. CONSIDERATIONS FOR LEASE OPTION
Following considerations should be made while gathering the information about leases:
1. Compensation-related incentives to leases
A manager whose bonus depends on return on invested capital will prefer lease to purchase of, say, office space, unless the lease is capitalized on the balance sheet. As by investing capital in the purchase of hard assets will not be productive for the organization and the organization will not get any return on that investment. Leasing the equipment will enable the organization to invest in more liquid and productive securities and assets. This will increase the organization's return on investment and will have a positive impact on the compensation of employees. (Rowland, 2001)
2. Specialization in risk-bearing
For unincorporated business leasing reduces the concentration of wealth in one activity, and can facilitate a more efficient allocation of risk bearing. Leasing enables the organizations to invest their money in a pool of assets rather than in the purchase of a single asset. This reduces the liquidity risk as the organization can now invest its capital in a portfolio. For unincorporated organizations this is a very attractive provision as these organizations possess a limited amount of capital for initial investment and they have to hedge the risk carefully. Small businesses that do not have a fixed income can purchase unnecessary equipments through leasing and can use the funds to improve their liquidity. (Rowland, 2001)
3. Sensitivity to use and maintenance decisions
The more sensitive the value of an asset to maintenance and use decisions, the higher the probability that the asset will be purchased. While leasing the equipment, it has been determined that, the requirements to maintain the equipment may be different from that of owning. The decision to purchase or lease the equipment may vary depending on which party is responsible for bearing the unpredictable maintenance costs and depreciation expenses. If the equipment has the tendency to depreciate in a short period of time and it has a high maintenance cost then it is better to…