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The net advantage to leasing is a calculation to determine the benefit gained from leasing an item over making a direct purchase. While this concept can apply to both individuals and businesses, its most common use is facilities or equipment purchases made by businesses. Net present value is a basic finance companies will use to determine the net advantage to leasing versus a direct purchase. Net present value compares the future cash flows from each option against the present cash outflows need to lease or buy the item.
To calculate the net present value, business owners and managers will need to start by estimating the future cash inflows generated by the new item. In some cases, these inflows may be the same under the lease or purchase option. However, companies may get a higher quality item under a lease rather than a purchase, since leasing may allow the company to obtain a better quality item for less money. To complete the first half of the formula, business owners and managers will discount the cash flows using a return-on-investment formula and add up the total of these figures.
The second half of the net present value formula to determine the net advantage to leasing is calculating all the costs associated with leasing or purchasing the item. Costs will include cost of items, sales tax, shipping or freight expense, installation fees and wages for employees setting up the item, among other items. To calculate the net present value, deduct the total current cash outflows from the total discounted cash inflows. A net advantage to leasing will mean that the future cash inflows from leasing the item will be higher than the net present calculation from purchasing the item.
Companies will lease equipment if they will gain a non-financial net advantage to leasing. For example, business technology equipment or applications often become outdated very quickly, meaning the company will need to upgrade or replace these items. Additionally, maintenance fees or other corrective measures may cost more money if the company purchases an item. Under a lease agreement, the supplier of the item will often repair or correct issues at their own cost, since they still own the item.
Lease may also allow the company to either purchase the item at the end of the lease or exchange it at low or no extra costs. This helps the company to have a strategy in place for advancing its operations through planned upgrades — another net advantage to leasing.
I am on the other side of this equation. I work for a large equipment leasing company. Companies needing a particular piece of gear call us up, we agree on terms, then we buy it and they pay us on a monthly basis. What happens to it at the end of term can vary case by case, and we agree on that when we write the contract.
Basically, we own things on behalf of other people. We have a very large line of credit, which we use to buy the things people want to lease. They pay us a tidy profit to have us deal with the hassle of owning it, and mostly of getting rid of it at the end. We don't mind this because we are very familiar with this process, so we have buyers for a lot of the things. Basically, everybody wins.
@ emtbasic - I know what you mean about being stuck with outdated gear. I am in the IT industry, and it seems like things become obsolete here in the time it takes you to have it shipped from the warehouse to your location.
I have been using computers for a while now, and it has always been like this, at least in the last 20 years. I remember ordering a computer in the 1990s where by the time the system got to us (it still took around three weeks after you ordered back then) the price had dropped twice and it was shipping with a bigger monitor. They called us and offered a credit, we didn't even have to
I remember a famous ad someone had placed in a newspaper that got scanned and passed around online, where a company was trying to sell a mainframe computer they had bought 15 or so years earlier.
This thing had cost millions of dollars. They built a building for it, and it had a big staff dedicated to its running. They were only asking a couple of thousand dollars, plus you had to move it from their site. I don't think anyone ever took it.
If we bought our computers, we would have to figure out what to do with the old ones every three or four years, and I don't think anyone would want to buy them. So we lease, and let someone else worry about it.
We lease a lot of the equipment for our business for a couple of reasons:
First, we have a fleet of vehicles and it would be considerably more expensive to buy them outright. We also save a lot of money on maintenance, depreciation, and repairs by leaving all of that to the car leasing companies and keeping a fleet of fairly new vehicles. We are in a pretty image-based business anyway, so new-looking cars are important for our sales and executive teams.
Second, the other equipment we use would just plain be too expensive to buy. I'm talking millions of dollars. By leasing it we can pay on a monthly basis as we get cash flow, and we aren't stuck with a shop full of gigantic, heavy, outdated gear when we're done with it.
Of course, we also get a lot of tax advantages for leasing too, so I makes sense for us.