How do you determine whether you should lease or buy a piece of equipment for your business?
Let's assume you're faced with the following lease-or-buy decision:
You can purchase a $50,000 piece of equipment by putting 25 percent down and paying off the balance at 10 percent interest with four annual installments of $11,830. The equipment will be used in your business for eight years, after which it can be sold for scrap for $2,500.
The alternative is that you can lease the same equipment for eight years at an annual rent of $8,500, the first payment of which is due on delivery. You'll be responsible for the equipment's maintenance costs during the lease.
You expect that your combined federal and state income tax rate will be 40 percent for the entire period at issue. You further assume that your cost of capital is 6 percent (the 10 percent financing rate adjusted by your tax rate).
EXERCISE
Using a cash flow analysis, make a lease-or-buy decision.
Note: Even if cost isn't your sole criterion, a cash flow analysis is useful because it can show you how much you're paying for non-cost factors that may dictate your decision to lease.