Mini Case 8

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The purpose of this assignment is to explain core concepts related to lease vs. purchase and tactical financial decisions.

Read the Chapter 19 Mini Case on pages 796-797 in Financial Management: Theory and Practice. Using complete sentences and academic vocabulary, please answer questions a through f.

APA format is not required, but solid academic writing is expected.

This assignment uses a rubric. Please review the rubric prior to beginning the assignment to become familiar with the expectations for successful completion.

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Mini Case 8

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MINI CASE Lewis Securities Inc. has decided to acquire a new market data and quotation system for its Richmond home office. The system receives current market prices and other informa- tion from several online data services and then either displays the information on a screen or stores it for later retrieval by the firm's brokers. The system also permits customers to call up current quotes on terminals in the lobby. The equipment costs $1,000,000 and, if it were purchased. Lewis could obtain a term loan for the full purchase price at a 10% interest rate. Although the equipment has a 6- year useful life, it is classified as a special-purpose computer and therefore falls into the MACRS 3-year class. If the system were purchased, a 1-year maintenance contract could be obtained at a cost of $20,000 per year. payable at the beginning of each year. The equipment would be sold after 1 years, and the best estimate of its residual value is $200,000. However, because real-time display system technology is changing rapidly, the actual residual value is uncertain. As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated Leasing would be willing to write a 1-year guideline lease on the equipment, including maintenance, for payments of $260,000 at the beginning of each year. Lewis's marginal federal-plus-state tax rate is 10%. You have 23. Banent Thess Pute Sumene. Tein narare. CareLamins Allerede hace those horisation. Dabby Cand Cayen Chapter 19 Lease Financing 797 been asked to analyze the lease-versus-purchase decision and, in the process, to answer the following questions. a. (1) Who are the two parties to a lease transaction? (2) What are the five primary types of leases, and what are their characteristics? (3) How are leases classified for tax purposes? (1) What effect does leasing have on a firm's balance sheet? (5) What effect does leasing have on a firm's capital structure? 1. (1) What is the present value cost of owning the equipment? (Hint: Set up a time line that shows the net cash flows over the period t = 0 to t= 1, and then find the PV of these net cash flows, or the PV cost of owning.) (2) Explain the rationale for the discount rate you used to find the PV. c. What is Lewis's present value cost of leasing the equipment? (Hint: Again, construct a time line.) d. What is the net advantage to leasing (NAL)? Does your analysis indicate that Lewis should buy or lease the equipment? Explain. e. Now assume that the equipment's residual value could be as low as $0 or as high as $100,000, but $200,000 is the expected value. Because the residual value is riskier than the other relevant cash flows, this differential risk should be incorporated into the analysis. Describe how this could be accomplished. (No calculations are necessary, but explain how you would modify the analysis if calculations were required.) What effect would the residual value's increased uncertainty have on Lewis's lease-versus purchase decision? f. The lessee compares the cost of owning the equipment with the cost of leasing it. Now put yourself in the lessor's shoes. In a few sentences, how should you analyze the decision to write or not to write the lease?
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Running head: LEASE VERSUS PURCHASE DECISION

Lease versus Purchase Decision
Name
Institution
Date

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LEASE VERSUS PURCHASE DECISION

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Introduction
Before an organization buys equipment, it has to consider many factors. One of the primary
factors is to either lease them or buy them. The two options have advantages and disadvantages
depending on the exact situation of the company (Brigham & Ehrhardt, 2013). Leasing involves
the application of capital budgeting concept to decide if leasing is a better option than buying. For
a company to make a good decision in any given situation factors like financial options for
purchase versus leasing should be considered. If cash involved is little, leasing is the best option
because the monthly payments are usually smaller compared to buying. The paper provides a brief
discussion on leasing versus purchase decision.
a. Parties Involved in a Lease Transaction
The two parties involved in leasing are lessor and lessee. A lesser is any person or company
authorized to perform leasing issues. In this case, the leaser is the equipment manufacturer Lewis
securities contacted. A lessee, on the other hand, is any person who obtains the rights to make use
of the leased assets and is supposed to pay a specified fee b...


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