Lease vs. Buy Decision

Definition

The lease vs. buy decision is a financial analysis that compares the costs and benefits of leasing versus purchasing an asset, such as a piece of equipment or a vehicle. This decision-making process is an important part of solving time value of money problems, as it involves evaluating the long-term financial implications of each option.

5 Must Know Facts For Your Next Test

1. The lease vs. buy decision involves comparing the present value of the total lease payments to the present value of the purchase price and associated financing costs.
2. Leasing can provide advantages such as lower upfront costs, potential tax benefits, and the ability to regularly upgrade equipment, but it also means the asset is not owned at the end of the lease term.
3. Purchasing an asset outright can lead to long-term ownership and the potential for resale value, but requires a larger initial capital investment and may have higher maintenance and insurance costs.
4. The optimal decision depends on factors such as the expected useful life of the asset, the availability of capital, tax considerations, and the opportunity cost of the funds used.
5. Sensitivity analysis, which involves varying key assumptions, is often used to assess the robustness of the lease vs. buy decision.

Review Questions

• Explain how the lease vs. buy decision relates to solving time value of money problems.
  • The lease vs. buy decision is closely tied to solving time value of money problems because it requires evaluating the present value of future cash flows associated with each option. This involves discounting the stream of lease payments or the purchase price and financing costs back to the present, using an appropriate discount rate. By comparing the present values of the two alternatives, the decision-maker can determine the more financially advantageous option, which is a key step in solving time value of money problems.
• Describe the factors that should be considered when making a lease vs. buy decision.
  • When making a lease vs. buy decision, several key factors should be evaluated, including: the expected useful life of the asset, the availability of capital to fund the purchase, the potential tax benefits of each option, the opportunity cost of the funds used, and the financing costs associated with a purchase. Additionally, the decision-maker should consider the flexibility and potential for upgrades provided by a lease, as well as the long-term ownership and resale value benefits of a purchase. Sensitivity analysis can also be used to test the robustness of the decision under different scenarios.
• Evaluate the potential advantages and disadvantages of leasing versus purchasing an asset.
  • The key advantages of leasing an asset include lower upfront costs, potential tax benefits, and the ability to regularly upgrade equipment. However, leasing means the asset is not owned at the end of the lease term, and there may be restrictions on how the asset can be used. Purchasing an asset outright provides long-term ownership and the potential for resale value, but requires a larger initial capital investment and may have higher maintenance and insurance costs. The optimal decision depends on the specific needs and financial constraints of the decision-maker, as well as the characteristics of the asset in question. Carefully weighing the pros and cons of each option is crucial to making an informed lease vs. buy decision.

Related terms

Net Present Value (NPV): A financial metric that calculates the present value of the expected future cash flows from a project or investment, allowing for comparison of the relative profitability of different options.

Opportunity Cost: The cost of the next best alternative that is given up when making a decision, such as the potential return that could have been earned by investing funds in a different asset.

Financing Costs: The interest and other charges associated with borrowing money to purchase an asset, which must be considered when evaluating the lease vs. buy decision.