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The decision on whether to buy or lease on equipment for a certain project would depend on a number of factors. The first significant factor to consider when making the decision to lease or buy is the total cost. There are various elements of cost to take into account. Some of these costs are purchase price of the equipment, transportation and installation cost, the cost of depreciation, and cost of repairs among others.
In the example provided, leasing the equipment will attract costs such as lease payments and maintenance. Therefore, the after tax net cash outflow from leasing amounts to $36,000 in the first year, $36,600 in the second year and $37,200 in the third year. On the other hand, purchasing the equipment will attract costs such as maintenance, depreciation, interest payment, and repayment of the principal amount of loan. Thus, the after tax net cash outflow from buying amounts to $39,000 in the first year, $28,600 in the second year and $56,200 in the third year. Reflectively, it can be observed that leasing is cheaper.
The second factor to consider is the tax bracket of the firm. It is worth noting that both leasing and purchasing options provide tax benefits. Therefore, it is important to analyze how each option will affect the tax position and the cash flows. Leasing results in a tax savings amounting to $73,200 while purchasing option yields a tax savings amounting to $85,200. The third factor to take into account is the expected residual value of the property.
If the residual value is more than the book value at the time of disposal, then the company will have a cash inflow. From the example, the book value of the asset at the end of the third year is $60,000 while the price at which the asset is sold amounts to $50,000. This results in a loss of $10,000. The loss yields a tax savings of $4,000. Thus, it can be observed that the expected residual value results in a tax savings.
The fourth factor to take into account is the time value of time. The present value of the cash outflows depends on their timings. From the calculations, the present value of cash outflow for purchase option ($101,281) is greater than the present value of cash outflow for leasing option ($90,892). In this case, leasing option will be preferred because the present value of the cost of leasing is lower than the present value of the cost of the purchase option.
The other factor to consider is the term of the lease. A lease with purchase option will be suitable because it offers the company an option to buy the equipment. Some of the other factors to consider are trade-in value at the end of the lease period, ability to find a suitable product to lease, and the ability to have control of the property (Peirson, Brown, Easton, Howard, & Pinder, 2008). Thus, in this example, it is economical for the company to lease the equipment because it requires a low capital outlay.
Reference
Peirson, G., Brown, R., Easton, S., Howard, P., & Pinder, S. (2008). Business finance. United States: McGraw-Hill.
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