Term Paper: Leasing vs. Purchasing Computer Equipment?

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SAMPLE EXCERPT:

[. . .] (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)

It helps in raising more funds for the organization. Financing the purchase of equipment through loans has certain restrictive conditions and it also have a negative impact on the debt to equity ratio and credit standing of the firm. On the other hand, leasing an equipment does not increase the overall liability of the firm, therefore, the firm can borrow funds from other organizations by issuing bonds and stocks as its debt to equity ratio is not very high. (Kishore, 2008)

3. CONCLUSION

The net present value of the cost of purchasing the computer equipment is $88,461.

The net present value of the cost of leasing the computer is $80,793.

It is evident from the net present values calculated for both the options that leasing is the better option. As the net present value of the purchase option is greater than the net present value of the lease option, mathematically

88,461-80,793= 7,668

Leasing equipment will result in easy management of IT equipment through local company's extensive knowledge of machines and service plan. Thus the lease option is more compatible for the company.

In addition to that, the lease option costs less and hence it can benefit the company in financial terms.

If the company goes for the purchase option then the company would incur a net cash outflow of $126,965. It is a large outflow and it can have a negative impact on the liquidity position of the company. Moreover, the purchase option will have an unpleasant impact on the cash flow statement of the company as well.

4. RECOMMENDATIONS

It is recommended for Kerry Hamilton at GE to lease computer equipment for her department of 100 employees. As all the calculated data reflect that leasing the equipment will be profitable for the company.

The lease option will also provide the company with a flexible payment structure so it is a preferable option for the organization

As the equipment in hand is a technological equipment therefore, it is recommended that the company should go for the lease option as it will enable the company to take full advantage of the useful life of the equipment.

It is recommended for Kerry Hamilton to include a service plan in the lease agreement for an additional annual fee of $500.

The company can enter the clause for service contract in the lease agreement and can negotiate with the lessor regarding this clause.

It is recommended that the company should add a service contract because the computer equipment require timely maintenance and if incurred separately, the maintenance expense will cost the company more as compared to the service contract.

APPENDICE

Given below are the details regarding the specifications of lease and purchase option. The Net present value was calculated by diving the net cash flow by (1+i) n..

Data for Lease And Purchase Option

The present value factors were as follows:

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

1

0.909

0.826

0.751

0.683

0.621

Comparison Between Net Present Values of Purchase and Lease Option

It is evident from the net present value of both the options that leasing is the better option. As the… [END OF PREVIEW]

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