When the economy is robust, there are advantages in buying any equipment. With the economic downturn the credit market tightens which increases the cost of debt. Therefore, any decision to buy or lease should consider the impact on the profitability of the business before arriving at the decision. In case the firm considers leasing as the best option then the first critical element is the interest rate the financier would like to charge. The tenure of the lease period and the leasing method should also be considered so that the firm gets the best option on leasing at reduced cost.
In the case of AMG the recommendation for the purchase or lease of 7,542 personal computers within a period of 12 months can be made based on the comparison of net present values (NPVs) of the lease proposal submitted by the leasing company Forsy to the NPV of the buy option. The results of the comparison of the NPVs indicate that leasing the PCs is more cost effective. The leasing option appears to be better than buying the PCs in view of the constraints in IT rollout of the company. The calculations of the NPV should take into account the terminal value of the computers assumed to be purchased by the staff to the extent possible.
However, it may be the case that most of the computers at the end of the useful life are to be disposed off by the company incurring additional cost in case they are purchased. Leasing has the distinct advantage of alleviating the time-consuming and expensive task of disposing off the equipments. “Traditional rewards due to flexibility, off balance sheet effects, conservation of income factors, 100% financing, or obsolescence avoidance remain the leading motivators for leasing to be the single most widely used method of external finance today.” (ArlingtonCapital, 2009)
The lease proposal by Forsy includes two lease option lines with a 24 month and 36 month leasing options. Even though 24 months’ lease line lease rate factor of 0.0400 which is higher than that for 36 months (0.0311) the present value of the repayments over the 36-month period is more than that under 24-month lease proposal. Therefore, it is recommended that the company pursue the 24-month proposal. The company can opt for a rolling lease line which is the best choice as the lease agreements are staggered based on the rollout schedule.
Since the rollout of all the 7,524 computers are scheduled within a period of 12 months, if the company adopts the coterminous lease the monthly commitments for the company on account of lease payments towards the end of the coterminous period will be more. Moreover, with the constraints on rolling out all the PCs in the same month the coterminous rollout would require AMG to pay for the PCs which were not yet acquired.
On the question of off-balance sheet financing, considering the criteria under which an operating lease is to be capitalized, it is advisable that the company buys the software instead of leasing, as such leasing would make the lease of software be shifted to capital lease and cannot supplement the off-balance sheet financing intentions of AMG. Software can be considered as an asset because its value is recoverable and usable over an extended period. Therefore, the software can be purchased and the value capitalized to be depreciated over the period of its use.
Reference
ArlingtonCapital. (2009). Leasing Services – Why Lease?. Web.