Buying versus Leasing - Assignment Example

? Buying Versus Leasing Buying Versus Leasing More than often, choices made when opting to buy or lease a car are influenced by economic and managerial decision-making factors. In most cases, comparison of the purchase price and lease payments, comparison of present value and ownership at the end of the leasing period influence the decision undertaken. In addition, analysis involves assessment of the benefits that are accrued from purchasing of a vehicle over leasing of vehicles. With many choices to decide upon, it is essential to understand the costs, cost benefit analysis and risks of loss either associated with the purchase or leasing of vehicles. More significantly, capital budgeting is more commonly used in management planning as it gives an outlay of the long-term implication of purchasing or leasing a new car. Therefore, the main aim of the thesis of this paper is to not only evaluate the suitable choice of acquiring cars, but to also analyze the financial and non-financial factors that influence decision making. Executive Summary Investment decisions are based on economical and effective factors that make the purchase of cars more viable as compared to leasing a car. More significantly, application of capital budgeting in deciding on purchases takes into consideration the viable choice after carrying out appraisal based on the expenses related to buying and leasing and their cost respectively. As a result, capital budgeting is more commonly used in management planning as it gives an outlay of the long-term implication of purchasing or leasing a new car (Thomas & Maurice, 2011). More so, considerations should be undertaken based on the provision economic decisions based on interest rates, sources of finances, end of lease fees, loan terms, personal guarantees and operating cash while making decisions on whether to procure or lease a car as related to economical costs. Even though, leasing allows for payments within small intervals it is considerably expense as the payments accumulate over time with no long-term benefit being derived. Definition In the acquisition of new assets, there are two choices based on whether to lease or purchase. More considerably, leasing comes either as operational or capital lease depending on the terms of the contract. In capital leasing, an individual is allowed to finance the maintenance and use of the car while at the end of the agreed lease term take up ownership after undertaking a nominal buy out lease. On the other hand, operational lease allows for renting of the car, and as a result, there is no ownership entitled at the end of the contract as the lease term allows for monthly payments (Powell, 2009). Nonetheless, purchases allow for payments to be made at the initial purchase and ownership of the asset is transferred immediately to the buyer. Even though, the leasing of a car seem viable it involves regular payment of the leasing fee as the returns of the vehicle passes back to the initial owner, when the lease term comes to an end as compared to purchases where upon payment of the purchase price legal ownership is issued immediately to the buyer of the car. As a result, there is a significant difference in terms of payments and ownership term in the purchase and leasing of a car. More considerably, to understand about leasing agreements, it is essential to understand about the lessor as the leasing company in which they deal with leasing of cars based on rights that govern the contract (Powell, 2009). While the leaseholder, or lessee is an individual who utilize services of the leasing company through leasing of vehicles. As the lessee uses the vehicle, they make payment based on calculated monthly lease charge this payment made are considered to cover the interest that is charged by the leasing company for services offered. As a result, the leaseholder makes a choice on the type of lease to undertake. If an individual chooses capital lease, it is known as closed-ended lease because the leaseholder does not get a guarantee of redeeming a residual amount at the end of the lease agreement period as stipulated by the contract. On the other hand, the choice of an operational lease allows for an open-ended contract that guarantees redemption of the value of the leased car at the end of agreed lease period (Powell, 2009). More significantly, there are costs associated with the use of vehicles. More so, the relevant cost is based on the expects revenues and costs associated that differ among alternatives, of purchasing and leasing are considered when analyzing the best suitable alternatives In addition, the valuation of costs and revenues associated with purchases and leases involve undertaking of a suitable discount rate that is commonly considered as the interest rate. As a result, the discount rate gives a calculation of the expected present value taking into considerations the expected yearly benefits and costs. Besides consideration of discount rate, the influences of inflation on the changes in price are included in cost estimation (Thomas & Maurice, 2011). This is because in economics inflation, which is measured as the proportionate rate of changes expected in the general price level, when related to the proportionate increase in a definite price. In addition, the managerial decision made on whether to purchase or lease a vehicle will depend with the Cost-Benefit Analysis (CBA) valuation that should be highly maximized. This is because consideration of the expected costs and benefits of derived from the alternative approaches to be undertaken in the proposed activity assist in the determination of the best alternative to invest in (Thomas & Maurice, 2011). In addition, consideration of both financial and nonfinancial factors give the benefits derived from the total discounted costs of both choice of leasing and purchase of a car. As a result, the option with the lowest cost should be continued as opposed to the one with high costs associated with its undertaking. Considering that, economics value the amount of money spent is to be based on the present value calculation take into consideration the net present value. As a result, the discounting of the value of payment considers the dollar value at present as compared to value of the same dollar in the future, as it takes into account changes in values as a result, of changes in the inflation rate (Moschandreas, 2000). Assumptions are also made based on the residual value that is considered as the value of a leased or bought vehicle as it depreciated during vehicle usage based on an estimated future value. Considerably, this paper will focus on the costs, measurements, analysis and summary on the economic and managerial reasons based on the choice of purchasing the vehicle as being viable (Thomas & Maurice, 2011). The method based in explaining purchasing of a car as a viable option is determined by three-step method that involve comparison of the purchase price and lease payments, comparison of present value and ownership at the end of the leasing period. In addition, the analysis will involve assessment of the benefits of purchasing a vehicle over leasing of vehicles. As a result, this evaluation will undertake development of a suitable method for evaluating the cost-benefit analysis derived from leasing versus buying vehicles that have been used in buying versus leasing decision considering economic and financial benefits derived. Factors that Affect Decision on Whether to Purchase or Lease a Car More than often, there are several benefits accrued from purchases of a car as compared to leasing. As the legal owner of the vehicle one is entitled to use the car to the greatest of satisfaction as compared to leasing as a result, there are no limits on time and distance (Powell, 2009). As for purchased vehicles the lifespan depends on how long the car will be in excellent condition with no stipulated miles as compared to leased cars that have mostly leased agreements of 5 years with expected mileage that do not exceed 55,000 miles. As a result, when there millage exceeds the stipulated 55,000 miles one pays a penalty for all recorded mileage that exceed the set limits. Unlike in purchased vehicles where ownership transfers to the owner. Leases involve lack of ownership unless; it is an operational lease where ownership transfers at the end of the lease agreed period leasing a car is not viable. More considerably, whether it is a lease or purchase it is the users responsibility to carry out repairs and maintenance based on the vehicles excess wear and damage, additional equipment that are replaced besides undertaking service of the vehicle based on the stipulated manufacturer’s recommendations Powell, 2009). Nonetheless, the investment in highly maintaining of the vehicle is not a burden to the owner of purchased vehicles as compared to those leasing car where the costs covered by the warranty remain the leaseholder responsibility. Any additional investments on the car to make it suitable for use is for the advantage of the owner who issues his property for leasing as ownership remains at the end of the lease period. As an investment purchase, of the car allows the owner to take insurance to cover for accident costs, the insurance company covers the costs, and as a result, the owner is saved from losses incurred from accidents. On the other hand, a lease agreement binds a leaseholder, as it does not allow for termination of the lease contract amount does not change, as the leaseholder is still bond by the lease agreement even after an accident. In addition, a lease contract does not give a leaseholder their own choice of insurance because they have to maintain insurance covers that meet the leasing company set up standards. More considerably, a leaseholder suffers loss because it is a requirement for payments to be made even at the point where the car is wrecked and cannot be used within the lease period. Above all, reimbursements by the insurance company are usually lower that the amount paid for the lease contract because you remain responsible for the full amount of accident related expenses. The option of purchasing a vehicle allows for ownership that acts as an additional asset that can act as a security. More so, the payments of costs are at one point whereas where the purchase is supported by facility the repayment is at favorable interest rates as ownership is acquired even before clearing the loan. On the other hand, liability for payments could be high for leaseholder as compared to owner in case of loan default in times of hard financial and economic crisis (Hirschey, 2009). Nonetheless, in the lease agreement the dealership usually recovers the car and sells it on auction leaving the leaseholder with no car to use. Above all, if the sale of the leased car recovers a value less than the amount the leaseholder owe for the lease agreement, an individual remains legally responsible to pay the difference. Even though, both purchased and leased vehicles depreciated the factors described show that at the end of the lease period the leaseholders do not benefit because payments are made as any end-of-lease fees even as the car is returned to the dealer. In addition, if the leaseholder decides to terminate the contract before the end of the lease contract requires payments of agreed amounts to be made (Powell, 2009). With a lot, of regulations and restrictions that bind lease agreement it is considerably decisive to purchase a car because one receives ownership and derives maximum cost benefit as the possession remain as an asset within its useful lifespan. Measurement In making decisions between leasing verses purchase of a car, it is necessary to illustrate using a mathematical example that support the decision on why the purchase of a vehicle is preferable as compared to leasing. For example, the current charges for undertaking lease of a car accrue to a total cost of $ 32,000 spread over a period four years. According to the dealer, the lease cost comprises of the normal lease charge of $20,000 for the use of the leased vehicle while the difference was to cover for depreciation charges of $12,000 are also charged in the total lease fees. As a result, the leaseholder had to make monthly payments of $8,500 and $ 7,500 at the end of the contract period as the lease fees that cover for the lease agreement. On the other hand, purchases made of a similar vehicle from acquisition on one-time purchases totals to $30,000, plus other acquisition charges fees. The expected related costs accrue to repair and maintenance of similar in both the leasing and purchasing option at an average per month. Purchase Price versus Lease Payment Analysis In calculations made below there are several assumptions made including the fact that both vehicles that are purchased and leased have the same quality of service and time frequency of maintenance as per manufacturers specifications (Powell, 2009). The expected salvage value of purchased vehicles will have zero value at the end of the four years, and as a result, there is no value of return because the vehicles are considered worn out for resale. In addition, we assume that the above lease agreement contract remain as a capital lease with no expected transition costs of moving the leased vehicle from ownership to leasing. More significantly, the cost of vehicle leasing and actual initial price is spread over a period of four years, which is the life expectancy span. Based on the information provided above it is relative to distinguish the initial cost caused by the decision to purchase or lease. Purchase Lease monthly payments Year 1 $ 30,000 $ 8,500 Year 2 $ 8,500 Year 3 $ 8,500 Year 4 $ 7,500 At this point of comparison, it is necessary to remember that the lease agreement value exceeds the purchasing price as the cost of purchasing at the beginning costs $ 3,000 cheaper. As a result, the lease purchase option is essential as it gives a fair economic comparison value (Powell, 2009). At this point, it is considered that leases at times specify the even distribution of costs over the lifespan of the usage of the leased vehicle. As a way of measuring the viability of leasing and buying option of a car, it is necessary to consider the present values of leasing and buying options. This is because, in economic consideration of effects time value allows for decision making of money invested. More considerably, it is necessary to calculate money value based on interest paid on initially borrowed funds as interest payments are made within the monthly-specified period. Assume that the interest rate of 14% based on the present value interest factor table below is Purchase Factor Present Value Year 1 $ 30,000 1.000 $ 30,000 Year 2 $0 0.8772 $ 0 Year 3 $0 0.7695 $ 0 Year 4 $0 0.6750 $ 0 $ 30,000 Purchase Lease monthly Factor Present Value payments Year 1 $ 8,500 1.000 8500 Year 2 $ 8,500 0.8772 7456.2 Year 3 $ 8,500 0.7695 6540.75 Year 4 $ 7,500 0.6750 5062.5 27559.45 Summary Even though, the use of lease contracts seems to be attractive because it offers more flexible as it seems to meet consumer needs, there is no doubt that many consumers still prefer to buy their own cars rather than lease. More than often, there are several benefits accrued from purchases of a car as compared to leasing. Ranging from the cost benefits accrued in case of inflation occurrence and savings based on the payments and freedom to resell purchased vehicles remains viable. Even though, the purchase of vehicles involve high costs at initial acquisition with the costs reducing as the remaining costs involve reduction of costs associated with repairs, services and maintenance remain high. Without a doubt, given the choice on whether to purchase or lease vehicles it is essential to carry out appraisal depending on the prevailing market conditions including financial and nonfinancial benefits. More comprehensively, the influences of changing regulations and restrictions that bind lease agreement make it considerably decisive to purchase a car because one receives ownership and derives maximum cost benefit as the possession remain as an asset within its useful lifespan. References Hirschey, M. (2009). Fundamentals of managerial economics. Mason, OH: Thomson/South-Western. Moschandreas, M. (2000). Business economics. London New York: Business Press. Powell, S. (2009). Management science: the art of modeling with spreadsheets. Hoboken, N.J: Wiley. Thomas, C. & Maurice, C. (2011). Managerial economics: foundations of business analysis and strategy. New York: McGraw-Hill/Irwin. Read More