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Comparing Leasing and Purchasing
The main advantage of leasing is that your initial outlay of cash to gain the use of an asset is generally less for leasing than it is for purchasing. However, perhaps the main disadvantage of leasing is that you usually end up paying out more over the asset's life than you would have paid if you purchased the asset. How do you reconcile these two factors? Well, one way is to do a mathematical analysis of your net cash flows that would result from leasing and from purchasing.
A cash flow analysis provides an estimate of how much cash you would need to set aside today to cover the after-tax costs of each acquisition alternative. The analysis takes into account the "time value of money," which is basically the concept that you don't need to have $50 today to pay a $50 expense in one year, due to the fact that you can earn interest on your money. To perform the analysis, you need to know or assume certain facts, including:
- purchase and financing terms
- lease terms
- your combined federal and state income tax rate
- the asset's expected useful life to your business (for depreciation purposes)
- the asset's estimated value, if any, at the end of its useful life to your business
- your cost of capital
- any other costs that you would incur if you leased the asset but not if you purchased it, or vice versa (for example, you'd need to account for expected maintenance costs if the lessor was assuming responsibility for those costs)
For an example of how you'd go about doing a cash flow analysis, see our case study on the subject of leasing vs. purchasing.
