Analyzing Lease Vs. Buy DecisionsEssay Preview: Analyzing Lease Vs. Buy DecisionsReport this essayRunning head: ANALYZING LEASE VS. BUY DECISIONSAnalyzing Lease vs. Buy DecisionsBonnesante Research is a start up business in Irvine, California focusing on biotech, and is based on 30 employees. As it grows, company’s asset acquisition needs to be focused. Bonnesante needs to submit its first drug to Food and Drug Administration within six months. In order to run advanced analytical software for the preparation of the drug, it needs to acquire mainframe computer. Now the decision needs to be taken to either lease or buy the mainframe computer.
It is best to lease the mainframe computer for 18 months instead of buying it. The reason being is that the loan options were proposing significantly higher outflows and the leasing option of 18 month with no money down proposed the lowest present value of the cash outflows of the duration. Since Bonnesante is not a profitable company, the expenses for buying an asset will not be tax deductible, and loaning option will also require to record the transaction and corresponding liability on the balance sheet. But through the lease option, an asset will not need to be reported on balance sheet. Moreover, the technology can be outdated in the future and there could be a need of upgrading it. Due to all those reasons, operating lease is the best option that a company has at this moment.
Another scenario is that the Bonnesante requires an advanced spectrometer for its Research and Development program and the cost of the spectrometer is $2,000,000 but Bonnesante is now operating as a profitable firm. The options are to do a short term operating lease, a long term capital lease or to buy the spectrometer. Since Bonnesante is running as a profitable company now, and the need of spectrometer is a great asset for a company to have in R&D field and will not be obsolete in the long run and can be utilized through its entire economic life, buying spectrometer on a 40 year loan with the down payment of $113,608 seems to be a good decision over all. By buying this asset, Bonnesante will also have a benefit of claiming it as asset depreciation whereas it will not be an option in operating lease.
It is the sixth year of Bonnesante Company; it wants to convert into a fully integrated pharmaceutical company. It has also identified a plant but needs to be upgraded. Also the company is facing some cash flow crises that need to be solved. At this time, the decision needs to be made whether to buy, lease or capital lease the plant. Moreover, cash flow crises need to be settled.
The best option Bonnesante has is to buy the plant on a nine year loan and upgrade it. This will give Bonnesante to then sell and leaseback option. Sale and leaseback is an option for businesses that are facing short of cash. If incase Bonnesante would chose to lease the plant then it would have no option of upgrading it or selling and leasing it back. In addition, in order to solve the short cash flow crises Bonnesante would have no option but to take the bridge loan, which is though short term in nature but carries higher interest rate, which would have been much costly than buying the plant eventually.
There are various risks that need to be considered while making a decision for either to lease or buy. Purchasing an asset is the first thing that comes in the mind of the managers because the company would have an option of owning it and selling it whenever it wants. However, the factors that also need to be taken into consideration are that purchasing assets may not be a right decision for a company. It may ultimately have an adverse effect on a companys ability to adopt new technology (Brealey, Myers, & Marcus, 2007, 189). Also, it is even hard to replace a fully depreciated asset or the lack of capital budget may occur. Sometimes leasing provide several benefits to company such as reducing its cost, provide flexibility to company to avail the opportunity of new technology if needed rather than waiting for getting rid of an old asset in order to buy the new one. Also buying an asset makes companies to be
in a better choice to make decisions on a price. A more sophisticated market for the asset may be offered by leasing and may create a cost to be more appropriate to the company in its ability to make better decisions about the use it can afford to have. Some companies may make it a lot cheaper than others to lease the asset than to keep it for a long time. This is likely to change when the market shifts further from being too expensive. In some circumstances, when new technologies is available and new strategies to acquire new assets become available, it may help them to improve both their performance and the effectiveness of their investment portfolio.
5.9. Market Factors that Will Affect Asset Buying Policy In the case of equity investment it is crucial that investors will be aware of a variety of factors that affect the prices of their own shares. Investors are familiar with the effects of certain of these factors on equity markets, which typically include a combination of:
• higher share prices — asset valuations are changing so that the gains from a particular investment are increasing fast. This allows the market to continue to pick up on them and increase its share price as quickly as it previously did. Some of the more attractive characteristics of an asset that has not yet gained popularity are the fact that it has outperformed its peers more quickly as demand for those markets grows (Higgins & Doolittle, 2007; Reynolds, Susteren, O’Connell, & #038; Gower & Burtmann, 2011). Investors also recognize the fact that asset prices are expected to gradually decrease as demand for the same assets grows.
• more favorable share prices — investment value of a particular asset has increased steadily for many reasons such as the fact that such wealth may be available within an asset’s lifetime (Erie, 1998; Riggs & Hester, 2005; Gower & Burtmann, 2011). The increase in the relative share price of all asset classes is a much more favourable outcome for the investors who have invested in it since the early part of the 21st century (Lorimer & Gower, 2007).
• more favourable stock markets — many equity indexes are similar to the two stocks over which the market is expected to increase. A lot can be found in common among the stocks and some of the differences between the two are quite wide (Reynolds, Hester, & #38; Gower & Burtmann, 2011).
• higher interest rates — investment rates are at an all time low and the prices of equities in many of these indexes will continue to climb as the overall market moves from being stable to being unstable. High interest rates have an adverse effect on investors who have capital or other liquidity needs in order to keep up with rising value and hence the market will decrease in value. Higher capital markets are desirable because they reward investors with less risk of future loss and hence they are less likely to suffer losses in future. However, they come at the expense of investors with higher assets and because they also lead to the lower costs of financing investments (Pete & Doolittle, 2007). It can also result in a high stock price indexing or rising liquidity costs of low-cap stocks and can lead to a higher risk to large-cap stocks since a large proportion of those equity securities are in many countries where the stock market value is extremely low, hence it will be advantageous for investors to hedge on the value of the investment rather than the risk associated with any particular asset class. A high stock market indexing is, however, not always advisable as it can lead to a lower average return (Gower & Burtmann