Assignment#2
Capital Budgeting – (Lease-Versus-Buy)
Sunita Goel
PMAN 650, Section 9040
Professor: Dr Krishna Challa
UMUC
Contents INTRODCUTION 4 WHAT IS CAPITAL BUDGETING 4 SITUATION ANALYSIS 5 LEASE TYPES 5 APPLICATION 6 RISK IN “LEASE-VERSUS-BUY” OPTIONS 8 ADVANTAGES OF COMPUTING PRESENT VALUE: 9 CIRCUMTANCES IN WHICH CAPITAL LEASE IS BETTER ALTERNATIVE: 9 QUALITATIVE FACTORS IMPACTS ON FINAL LEASE OR BUY DECISION: 9 WHY LEASE? 10 Conservation of Capital 10 Payment Flexibility 10 Operational Flexibility 11 Upgrade Flexibility 11 Changing Requirement 11 Residual value Risk 11 Challenges of Leasing 11 WHY PURCHASE? 12 Useful Life Considerations 12 Easier to Purchase 12 Past Leasing
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Conversely, insufficient capacity or inefficient computing resources can stunt growth. The company that waits until it can afford to purchase the right hardware and software may find itself unable to remain competitive. Moreover, although businesses would rather keep their credit lines open for unforeseen events, they must sometimes act quickly to adopt economically attractive new technology. Before we examine the attributes which make leasing attractive to so many companies we need to review two most common types of leasing arrangements.
LEASE TYPES
Although many variations of lease financing are available, potential lessees should be familiar with two general types of leases: the full payout lease and the fair market value (FMV) lease. The choice of lease is based upon the lessees’ long-term plans for the asset involved. A full payout lease is one in which the present value of the payment stream equals the acquisition cost of the asset. Options at the end of the lease typically include return, renewal, or purchase often for $1. The lessee is able to deploy and utilize the equipment, while the periodic payments of the full payout lease ease the financial burden of making a large IT acquisition. This option is a good choice when future ownership is desired, the dollar value of the equipment is substantial, the expected productive life of the assets is longer than five years, and the flexibility of spreading out payments would
Global Financial Corporation (GF) a subsidiary of Global Equipment Company (GEC) is tasked with handling financing for those customers who wish to purchase GEC heavy equipment. Currently GF only processes 51% of the leases within the “10 days or less” time frame, with some loans taking up above 41 days. Ms. Rodriguez, the Vice President of GF has been directed to decrease loan processing time to 10 days or less with the current staff she has. The current structure of the analysis and evaluation stage does not maximize staff time effectively and as a consequence creates a bottleneck in the process. We recommend switching to a case manager structure. lLan applications can be processed and
Computer equipment had been acquired by lease and by purchases; leases had four years to run
Tech Startup Inc. (“Lessee”) is entering into a contract with Developer Inc. (“Landlord”) the rent Landlord’s newly constructed office building located at 15 Tech Drive in San Francisco, CA. The lease term is 10 years, and the estimated life of the building is 40 years. Lessee will occupy all 12 floors of the building. At the end of the lease term, Lessee has the option to purchase the property for $16.25 million. The fair value of the building at the time is expected to be $17 million. Monthly, Lessee will be required to pay $50,000 to occupy the building, plus a monthly supplemental rental cost based on Lessee’s sales (1% of sales). From experience,
upfront payment to lease the parcel of land for the expected 20-year life of the project.
It is beneficial for the company to lease office computers to minimise their expenses in other operations like recruiting and training new employees.
The regional trucking company should enter a sales-type lease to fulfill the requirement of 120 trailers needed for the new client. The difference between the fair value and the carrying value would be profitable for the trucking company. This will help to maintain its financial position. The risk of uncertainty in relationship with the client also can be eliminated through the sales-type lease because of the transfer of all risk and benefits to the new client.
According to IAS 17-10(d), a lease must be classified as a finance if either “the lease term is for the major portion of the asset’s economic life” or “at the inception of the lease the present value of the minimum payment amounts to at least substantially all of the fair value of the lease asset.” With
The lease or purchase problem is analyzed using capital budgeting or called through discounted cash flow. The opportunity cost of capital should be set at a level that is equal to the return a person could get if the money used to lease or purchase an asset. Present value is a variable which is used to compute the cash flows associated with the decision for leasing or purchasing. Basically, present value compute the costs a person incurs on money that is used to make lease payments or principal and interest payments on loans. An advantage of computer the present value is that it is easier to determine which option is cheaper than the other, lease or buy. When the net present value for leasing is less than it is for purchasing, leasing would be the least costly method for acquiring an asset. Contradictory, leasing would be more costly and will not be preferable if the present
First, based on the vision of the company which is to sell the business and achieving the targeted returns in the long term. Logically, long-term leases allow for long-term financial planning and that depending on the terms of the lease which will also allow the company to calculate the rental expenses over the long-run. Since the interest expenses are increased every year, thus, the company should act towards being highly leveraged. The company forecasted growth rate would
From the perspective of the lessee, this case would be treated as a finance lease because it reflects the relevant requirement in AASB117-Leases for finance lease. AASB 117 define finance lease as a lease that transfers substantially all the risk and rewards incidental to ownership of an asset. Some indicators for a lease to be classified as finance lease are: fair value, non-cancellability, contingent rent, transfer of ownership, bargain purchase option, lease term, economic life, and minimum lease payments (AASB 117 par 10-11). In this case, we can see that some of the indicators of being a finance lease has been satisfied. First indicator is the non-cancellability of the lease. It was indicated in the case that the lease Salohcin Ltd
The judgment to rent or buy significantly depends upon requirement as well as financial position. For instance, an organization may rent a piece of property or equipment in case the requirement for such will be short-term. A company has leased a business place for recent years while they were buying as well as building their long term office. Additionally, while finishing a building job, in case an additional machine is required, a business may lease the machine for much lower than having to buy. Some companies may just require a particular machine for one task; therefore a purchase is much too costly.
What would be the best option for a company to lease or purchase equipment? Each business owner’s situation is different. The decision to buy or lease business equipment is unique. It must be made on a case-by-case basis. Leasing equipment preserves capital giving the business more flexibility. While leasing can be good in the short run it can cost you more in the long run. We will look at the advantages and disadvantages of leasing. My research will look at the different options a company faces if they lease or buy and why it has become more attractive to lease.
A lease in this context is a legal document or contract between a landowner who is the lessor and a company (or individual) who is the lessee that grants the lessee rights to exploration and development rights to potential subsurface mineral commodities. Today there is no standard oil and gas lease form. At one point the “Producers 88” form was considered the standard form but today various oil and gas companies utilized several different types of lease forms as their starting point for negotiations. Generally their are two broad types of oil and gas lease forms based on the timing of the lease bonus payments. The most commonly used type is the “Pay-Up” lease which no bonus payments are due after the signing of the lease, instead the lessor gets one hundred percent of the lease bonus money combined with annual rental payments up front. The other type is the “Rental Lease” that is not as commonly used in which the lease, can lapse if the rentals are not paid in a timely manner by the company which would ultimately result in the termination of
Before beginning the brief description of different leasing options, it would be best to define the term ‘lease.’ According to Investopedia, the term ‘lease’ is a contract outlining the terms under which one party agrees to rent property owned by another party (Investopedia, no date). Furthermore, it seals/guarantees the ability for the lessee, the tenant, use of an asset and guarantees the lessor, the property owner or landlord, regular payments from the lessee for a specified number of months or years (Investopedia, no date). If the agreements and terms are not upheld to the agreement of the contract then both parties, lessee and lessor, face consequences (Investopedia, no date). Now to describe the
buy decision is also in favor of buying since the net advantage to leasing (NAL) is negative number. The NPV of leasing and buying were found to be negative indicating the projects will cost money rather than make money for the company. The NPV of leasing is ($82,966.11) however, for buying the costs are not as high showing an NPV of ($59,221.92). These values lead us to an NAL of ($23,744.19) which indicates buying is better than leasing.