Lease or buy decision
1 Lease or Buy
The decision whether to lease or buy an asset is a financing decision which interacts with the investment decision to buy the asset.
Identify the least-cost financing option by comparing the cash flows of purchasing and leasing.
The cash flows are discounted at an after-tax cost of borrowing.
2 Leasing
The lessor has ownership of the asset and so provides the initial finance for the asset.
The lessee has possession and use of the asset on payment of specified rentals over a period.
Example of lessors:
-Banks
-Insurance companies、
Types of asset leased:
- Office equipment
-Computers
-Cars
-Buildings
Advantage of leasing
Lessee may not be able to get a bank loan, so to rent the asset and obtain the use of asset.
Finance leasing may be cheaper than a bank loan.
The lessee may find the tax relief available advantageous.
Further benefits of operating lease
Neither asset nor lease obligation will be shown on financial statement, thus gearing ratio will no rise.
Operating lease provide more flexibility for asset with rapid technology development.
Other considerations
Who receives the residual value in the lease agreement?
There may be restrictions associated with the taking on of leased equipment. The agreements tend to be much more restrictive than bank loans.
Are there any additional benefits associated with lease agreement, for example maintenance or other support services?
3 Buying
The assumption is that buying requires the use of a bank loan （for the sake of comparability） .
The user is the owner.
The user will receive written down allowances on the asset and allowances against the interest payable on the loan.
Cost of capital
We must use the Post Tax Cost of Borrowing as our discount rate. As all financing cash flows are considered to be risk free, this rate is used for both leasing and buying.
Post-tax cost of borrowing = cost of borrowing x （1 - tax rate）
4 Method and format：
Step 1: Identify the cash flow of lease and buy
Step 2: Calculate the PV of cash flow discounting at post-tax cost of borrowing
Step 3: Select the lowest PV of costs
Back：Other ways of reducing risk
Next：Asset replacement
The decision whether to lease or buy an asset is a financing decision which interacts with the investment decision to buy the asset.
Identify the least-cost financing option by comparing the cash flows of purchasing and leasing.
The cash flows are discounted at an after-tax cost of borrowing.
2 Leasing
The lessor has ownership of the asset and so provides the initial finance for the asset.
The lessee has possession and use of the asset on payment of specified rentals over a period.
Example of lessors:
-Banks
-Insurance companies、
Types of asset leased:
- Office equipment
-Computers
-Cars
-Buildings
Advantage of leasing
Lessee may not be able to get a bank loan, so to rent the asset and obtain the use of asset.
Finance leasing may be cheaper than a bank loan.
The lessee may find the tax relief available advantageous.
Further benefits of operating lease
Neither asset nor lease obligation will be shown on financial statement, thus gearing ratio will no rise.
Operating lease provide more flexibility for asset with rapid technology development.
Other considerations
Who receives the residual value in the lease agreement?
There may be restrictions associated with the taking on of leased equipment. The agreements tend to be much more restrictive than bank loans.
Are there any additional benefits associated with lease agreement, for example maintenance or other support services?
3 Buying
The assumption is that buying requires the use of a bank loan （for the sake of comparability） .
The user is the owner.
The user will receive written down allowances on the asset and allowances against the interest payable on the loan.
Cost of capital
We must use the Post Tax Cost of Borrowing as our discount rate. As all financing cash flows are considered to be risk free, this rate is used for both leasing and buying.
Post-tax cost of borrowing = cost of borrowing x （1 - tax rate）
4 Method and format：
Step 1: Identify the cash flow of lease and buy
|
Buy: -Initial Investment & Residual value -Tax saving on WDA -Maintenance cost -Tax Saving on maintenance cost |
Lease: -Rental -Tax saving on rental |
Step 3: Select the lowest PV of costs
Back：Other ways of reducing risk
Next：Asset replacement
