Good Example Of Lease Versus Purchase Essay
Type of paper: Essay
Topic: Money, Taxes, Time, Value, Real Estate, Depreciation, Finance, Future
Purchasing versus leasing decisions are crucial in life, especially when they concern the choice of the residence. All else equal, a rational person will be looking for the alternative that has the lowest cost; that is the alternative that minimizes the present value of the future cash flows to be paid to enjoy usage of the good for the specified time period.
In this problem, leasing entails lease payments and maintenance costs. This cost is reduced because some of these expenses are tax-deductible – so after-tax cash flows should be discounted instead of pre-tax cash flows. There is no depreciation expense in a lease because the depreciation is upon the owner of the good (lessor) and not on the lessee. In the case of purchasing, lease payments are replaced by principal repayment and interest payments, moreover depreciation should be taken into account (which represents the loss of value of the good purchased) as well as cash flow resulting from the sale of the good at the end of the period. Once again, tax deductible expenses imply that after-tax cash flows should be discounted.
In this case, the after-tax cash outflows from leasing are $36,600, $36,600 and $37,200 for the year 1, 2 and 3. After-tax cash outflows from owning are $39,000, $28,600 and $56,200. Since these cash flows are discounted, the further in the future the cash flow happens, the less impact it has on the present value result. This result makes sense as debt repayments are initially composed mostly of interests, and over time mostly of capital. Thus, leasing is in general more advantageous for shorter time periods and purchasing for longer time periods (since you pay back the capital at the end of your loan).