Comparing Leasing vs. Purchasing Computer Equipment

¶ … LEASING vs. PURCHASING COMPUTER EQUIPMENT?

Leasing and Purchasing Computer Equipment

Scope

Considerations for Lease Option 7-9

Advantages of Financial Leasing 9-12

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?

INTRODUCTION

PURPOSE

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.

1.2. SCOPE

Leasing computer equipment is the most economical way to outfit GE's Human Resource Department with new computers.

1.3. BACKGROUND

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.

2. DISCUSSION

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 purchase the asset. (Rowland, 2001)

2.2. Advantages Of Financial Leasing

1. Operational advantages to the lessee:

Leasing ready-to-use equipment may be more attractive if the asset requires lengthy preparation and set-up. As the setup and preparation costs may be very high and may not fit the firm's cash flows. In addition to that, if the firm requires the asset for immediate use that it may not have the time that is required to be spent on the setting up and preparation of asset. Therefore, if the asset requires lengthy setup time then it is better to lease it. (Roch, 2005)

Leasing avoids having to own the asset that will be required only seasonally, temporarily or sporadically. It saves the cash of the organization and the firm does not have to spend large amounts of cash on the acquisition of unnecessary assets. (Roch, 2005)

Leasing for short periods provides protection against obsolescence. As discussed above, the life cycle of technology ranges between two to three years. Leasing technological equipment enables the firm to tie it to the lease schedule rather than a depreciation cycle. Therefore, a firm can take full advantage of the life cycle of technological equipment and can easily upgrade it with the advent of new technology through attractive terms under the same lease schedule. (Roch, 2005)

2. Financial advantages to the lessee:

Lease payments can be tailored to suit the lessee's cash flows (up to 100% financing, instead of the 80% limit by banks). Properly structured leases may be "off-balance sheet," avoiding Restrictions set by bondholders that prevent firms from taking on additional debt. The payments can be made annually; semiannually, quarterly or monthly with date of payments settled either in advance or on accrued basis. In addition to that, unlike other methods of financing leasing provides the lessee with the facility of 'stepped payments' that is the lessee may pay smaller installations at the beginning of the lease periods and larger installations at the end of the lease period. The lessee has the flexibility to adjust the payment schedule according to his revenue generation periods. (NOLO)

Leasing provides tax advantages from accelerated depreciation and interest expense. In case of operating lease the whole amount of the annual lease is deducted from gross profit, as an expense, for the calculation of taxable income hence the organization gets a tax relief. And in case of financial lease the assets are added to the books of the firm. Therefore, for the calculation of the taxable income, depreciation expense and interest expense are deducted from the gross profit and in this case again the organization enjoys a tax relief. (NOLO)

Disadvantages to the lessee:

Leased ready-to-use equipment may be of lower quality than custom built, resulting in lower quality products and lower sales. While purchasing the equipment the organization has the authority to get it customized according to its will whereas, in the case of leasing the organization does not enjoy any such benefit or authority. The leased equipment may be of low quality and it may not fulfill all the requirements of the lessee. (Kishore, 2008)

Seasonal leasing may affect equipment availability and pricing. The prices of equipment in case of seasonal lease may be high and there can be a negative impact on the availability of equipment. (Kishore, 2008)

The premium must be paid for the protection against obsolescence. The lease enables the organization to take the advantage of an equipment to the fullest and then return or upgrade it as per the requirements of the business but for this service the lessee organizations have to pay a premium and this premium increases the overall cost of the equipment. The cost of leasing the equipment, in case of premium is higher than the cost of purchasing the equipment. (Kishore, 2008)

Disadvantages to financial statement users: Off-balance sheet financing hides the true leverage of the firm.

The implications of off balance sheets financing with respect to tax and accounting issues:

It hides the true leverage of the firm. As the purchases made through the lease are not disclosed in the financial statements, therefore, the firm's total borrowed financing is not represented in the balance sheet. In case of operating lease the purchased asset is never entered into the books of the organization hence the borrowed financing is never mentioned in the balance sheet. This hides the true leverage of the firm from financial statement users. (Kishore, 2008)

There may be an increase in the liability of the firm, which is not disclosed currently. The assets purchased through leasing are a liability for the firms but the firms usually do not add lease obligations in their balance sheets. So an initial increase in the liability of the firm is kept hidden from the balance sheet and the financial statement users. (Kishore, 2008)

It may lead to an artificial increase in profits, which in turn means high taxes. In case of operating lease the purchased asset is not entered into the books and due to this a number of operating expenses, such as depreciation expense, interest expense, maintenance expense etcetera, in relation to that particular asset are not recorded and this lead towards an artificial boost in the profitability and the productivity of the organization and it may misguide the financial statement users. (Kishore, 2008)

Advantages:

It improves the debt equity ratio, which in turn may lead to better corporate reputation. The debt to equity ratio is calculated by dividing the firm's total liability by the share holder's equity. As the lease obligations are not recorded in the liability of the firm therefore, leasing enables the firm to have lower debt to equity ratio. Lower debt to equity ratio enhances the standing and reputation of the firms in the market and it also has a positive impact on the overall credit standing of the firm. (Kishore, 2008)