Lease Buy

Non Routine Business Decisions > Lease Buy

Leasing vs buying is a strategic decision-making tool that can help companies make the most of their finances. By comparing cash flow over different time frames, organizations can discover whether a lease or purchase makes more economic sense in terms of returns and savings. Leverage this approach to maximize the use of funds and ensure your bottom line stays healthy!

What is Lease Versus Buy Analysis?

When considering whether to lease or purchase an asset (car, computer, building, etc), a Lease versus Buy Analysis is the perfect way to determine which option will deliver maximum value. By comparing the cash flows of both scenarios – leasing and buying – you can make an informed decision that ensures the optimal use of your company’s funds.

Delivering Maximum Value

But how do you deliver maximum value? It comes down to opportunity cost. Purchasing an asset involves upfront investment, potentially offset by a loan. However, the asset is likely to be worth something when you are done using it. Conversely, leases require a much lower (sometimes nonexistent) upfront payment. Higher effective interest rates and no value when you return the asset can offset this benefit.

Why Is Lease Versus Buy Analysis Important?

How to perform a Lease Buy Analysis

Step 1: Determine Lease and Buy Inputs

Lease Inputs

Lease period – How long will the lease last
Lease Payments – The lease will spell out upfront and ongoing payments due, which provides an effective interest rate.
Maintenance Costs – Most leases require the leaseholder to pay certain maintenance and operating expenses (oil changes, utilities, etc.). Estimate the cost and timing of these expenses. You may also have to pay for wear and tear at the end of the lease term.
Upfront Costs – Some leases require a downpayment that you will need to consider
End of lease fees – Some leases require payments at the end of the lease
Early termination – Some leases require an early termination fee if you return the equipment before the end of the term
Tax Deductions – Leases can be deducted as you pay the monthly expense when the equipment is used for business purposes.

Buy Inputs

Investment Costs – These are the upfront costs or purchase price of the asset plus sales tax and freight.
Cost of Capital – Both the cost of capital for your business to assess the discount rate and the cost of debt if you choose to finance the asset.
Maintenance/Operating Costs – As the owner, you are responsible for all maintenance and operating expenses. Estimate the cost and timing of these expenses.
Capital Improvements – You may need to complete renovations and other improvements for long-term assets.
Monetization/Disposal Value – Most assets will have some value on the date of sale. This is sometimes referred to as disposal value or terminal value.
Tax Deductions – Purchases are capitalized as assets and can be depreciated over the vehicle’s life when used for business purposes. Using MACRS, you can accelerate depreciation and often save money.

Step 2: Build Amortization and Depreciation Tabs

Next, you must create amortization tables for any loan to calculate interest and principal payments. We can skip this piece since we will pay for the asset out of available cash. Regardless of payment method, you must create a depreciation table for Tax depreciation.

Step 3: Layout the Cash Flow Analysis

Now, lay out the two discounted cash flow analyses. The first will be for the lease and the second for buying. Don’t forget to account for the Tax shield and, of course, gain/(loss) on the assets.

Step 4: Compare the Net Present Value and Make a Recommendation

Compare the Buy NPV to the Lease NPV. Whichever one has the higher NPV is the winner! That said, always ensure that the cash is available to purchase. Otherwise, you must find a loan or lease regardless of the NPV.

Lease Buy Tools

Capital Budgeting