Lease vs. Buy Decisions Analyzing

¶ … Lease vs. Buy Decisions Analyzing Lease Vs Buy Decisions In a company's plan for acquiring valuable equipments and assets vital to its operation, there is always a question raised by the management and top executives, that is, whether to lease or buy. This important question is a common dilemma among financial managers of a company. Moreover, it is often a delicate task to analyze the pros and cons of buying or leasing depending on a given situation.

The most common approach in resolving issues in the acquisition of vital equipments and properties for a company is by means of carefully calculating the risks in both options. A financial manager of a company must put into consideration different factors that must be addressed cautiously in taking both options. Among the aspects that are given much emphasis: the economic life of an asset, the rate of it's obsolesce and most importantly the impact of the acquisition on the company's balance sheet and cash flow.

In the simulation "Analyzing Lease Vs Buy Decisions," arises different scenarios depicting usual situations being undertaken by company management, top executives and financial advisers. The study on the company, Bonnesante Research, provides both options, to lease or buy certain assets for its use in the company's operations. The primary objective of this simulation is to determine which among the two options would be applicable and be effective in the given circumstances.

Being a start up company and also due to the conservative financial standing of Bonnesante Research, the management is keeping a close watch over its cash flows by minimizing unnecessary expenditures and formulating calculated measures in order to deter and prevent cash flow problems. In the simulation scenario, the initial requirement being considered by Bonnesante is the acquisition of a mainframe computer.

This computer equipment would be useful for the company's objective to heighten its research for the first six months of its trial operations and support the requirement of the Food and Drug Administration. To acquire the equipment, Bonnesante must determine whether to purchase the computer mainframe outright or use the mainframe under an operating lease agreement. Based on the decisions made in the simulation, the company opted to lease the mainframe for 18 months.

The decision to lease was employed in consideration of the rapid obsolesce of computer equipments and comparatively to advance high-end computer workstations which is functioning at par with mainframes. Purchasing it was not advisable. Since Bonnesante is still not a profitable company, the depreciation of such equipments shall affect the present cash flow situation due to the un-applicability of taxes if the mainframe is to be purchased. Operating lease is a good option for equipments with high rates of obsolesces.

This decision only acknowledge the advise of Keith Kendall, managing director for HP Financial Services, about buying and leasing IT equipments stating that, If it's an appreciating asset, something that gains value over time, then you invest cash in it. If it's an asset that loses value over time, you invest somebody else's cash in it.

And since IT equipment typically loses its value over time, and in fact loses its value a lot faster than a lot of other fixed assets -- IT assets are a prime candidate for leasing in any company, large or small." (Noted by J. Schiff, 2005) The next scenario in the simulation is the requirement of a digital spectrometer. The equipment would cost almost 2 Million Dollars. During this time the company is experiencing profitability and all of its purchases and expenses would be taxed.

This time, the option chosen was to buy the equipment taking into account the actual lifespan of the equipment of 5 years enough to justify the cost of its purchase. The last scenario involves the company's plan to expand and be a fully integrated pharmaceutical company with its own marketing department and a dedicated plant to manufacture its products. This situation would again put the management to push through with a corporate decision whether to purchase the plant outright or under capital lease agreement.

During the initial encounter on this scenario, the option was to be under a capital lease agreement centering on the analysis that concentrating more on the primary strength of the company, which is research, does not justify long-term plans with regards to the purchase of the plant. To finance the purchase of the plant would be disadvantageous since future plans in widening its product portfolio would be its primary concern.

At this point, given the frail cash flow of the company, Bonnesante in its final decision opted to buy or purchase the plant with a future alternative for a sale and lease back arrangement. This evaluation on purchasing instead of leasing would benefit the long-term goals of the company. The plant would be upgraded into utmost standards as required by FDA and would have future options for a sale leaseback arrangement that would cover 8 years. Having purchase the plant would also give the company a clear advantage on tax savings.

In deciding between leasing and buying an asset for a company, financial managers and the rest of the management must be able to calculate and determine the different risks involved in both options. In leasing, important issues must be addressed as cautiously as possible. Decisions must give emphasis on different concerns such as, cash on hand or the present cash flow situation, deposits, periodical payments and the total cost based on a specified lease period.

For start-up and small to medium scale companies, gives certain advantages in terms of tax applications. Since payments for leases are usually expensed this help reduce income tax obligations for the company. Leasing also enables the company to exercise its buying options after the contract of lease expires. The downside in leasing is considerably minimal with high interest rates and pressures on periodical payments are among its disadvantages.

In buying options the utmost concern would be the cash flow and how the purchase would affect and deplete the cash reserves of a company. This then applies great impact on capital budgeting since purchasing an asset would consume much of the cash reserves which could be allotted to other company projects. The first rule in any business is to stay in business, and the key to staying in business is cash flow (Dan Wilson, 2005).

With the big amount investment involved for the purchase of equipments and assets, most company in this era gives more preference in leasing than purchasing. The other options that were cited in the simulation for asset acquisition are under capital lease and operating lease. A capital lease in its simplest form is practically a purchase. This is just by financing the acquisition through a leasing company. Upon full payment, the equipment would then be considered as part of the asset of the company.

This would be highly applicable on non-depreciating assets since the long-term investment would be paid off at the end of the lease contract. On the other hand, operating lease is a form of renting equipment, property or any asset pertaining to company use and operation. Until such time the company would be financially capable to purchase the equipment operating lease contracts are mostly.