To Buy Or Lease A Car: The Economic Considerations Involved Ashford University

Abstract

Decision-making processes in business and project management assignments require appropriate consideration of available options for value optimization. Financial decisions are for instance among the most affected decision making variables requiring consideration of different options to maximize value. In order to determine how value added coincides with the overall objectives of the organization, managers require analytical skills that facilitate cost-benefit consideration of each available option. In this discourse, the managerial decision making process is highlighted in terms of the best financial option from a cost-benefit analysis. The main task requiring the managerial consideration involves the determination of the best alternative in buying or securing leasing services for a vehicle. Securing a car through a lease agreement is considered under the discussed circumstances of the decision case. A section designated for the definition of the managerial task in question appears at the beginning of the presentation to contextualize the decision-making necessity at hand. To illustrate the compelling situation that makes the decision-making process imperative in the operations, a factors analysis follows the contextualized decision setting. To further clarify the position of the managerial decision taken, an enumeration of the financial benefits and costs measurement criteria and incidental variables is included. A build-up to the summary is generated with the help of the case analysis.

Introduction

In the definition of the decision scenario involving business operations requiring a vehicle, is it important to underscore the importance of availing a means of acquiring the services. In this case, the business is a small company offering VIP transport services that has secured a contract to ferry the CEO of a foreign investment company with business assignment in the country for a period of one year. Under the current capacity, it is not immediately possible to allocate a car due to a complete schedule in bookings. The possibility of operating under the current capacity without any change can only be achieved after two months, which is upon the expiration of immediate due contract. However, due to the strategic business opportunity presented by the new client, and the importance of the current contracts, acquisition of a car is inevitable.

Research Question

The management must devise the most appropriate answer to the business question involving buying or hiring. Is it financially viable to lease or buy a car for purposes of a sudden need to meet a temporary client’s needs?

Assumptions

Car buying decision is within a business context as opposed to private use.

Business context for car usage under consideration is for a shortage of goods ferrying for a temporary client.

Acquisition considerations are particularly important due to apparent financial constraints experienced across the world now.

Factors and Costs

In the determination of the appropriate option to be adopted for the acquisition of the car, the management will bring into perspective a number of factors against the cost analysis. Firstly, the need to attract business transactions of all levels of income within the difficult economic environment may be a survival tactic in maintaining sustenance. It therefore follows that the consideration of terminating existing contracts will lead to loss of revenues that are much needed in the economic sense. Accepting more revenue generation projects is perhaps the main viable option amid increased business maintenance costs. Secondly, the harsh nature of the business environment prevailing across the globe makes it difficult to quickly arrive at an acquisition option. Purchasing the car implies that the element of capital investment needed may not be directly advisable at a time when capital expenditure is unsupported by the economic conditions.

Thirdly, temporal aspect of the business implies that there are times when capacity fluctuates to occupy different operations level. To arrive at the exact cost estimation for the two options, it is important to highlight the cost aspects expected at the beginning and at the end of the chosen option. Buying the car will demand meeting of the cost of the car at the time of buying. This may involve the borrowing of money to finance the purchase at a high interest rate that covers the entire value of the vehicle. The fourth factor includes the fact that the business environment poses mixed feelings of uncertainties in sustenance implies that buying at the moment may lead to uncertainties in opportunities ahead. As an illustration, buying the car at the current high costs with looming uncertainty on recovery implies that the business will be undertaking risky business decision since returns distribution across the fleet is not ensured. In light of the setting under a lease agreement, it is possible to terminate the contract and avoid incurring further costs while taking advantage of the improved capacity.

Fifthly, interest rates play an important role in determination of the appropriate financing option (Bishop, 2011). Apparently, the both options must involve borrowing of money at some level to finance the acquisition and the relative cost of both options represents different value for money. In this regard, tying large amounts of capital during high interest and cost period is not in the best interest of the business in the long-term projections. Bearing in mind that the purchase option requires the entire cost to be cleared at the time of acquisition is disadvantageous during high interest periods. On the other hand, acquiring the car through leasing will only factor in costs incurred during the specified duration of time. Lease agreement at the beginning of the acquisition will involve the down payment and further costs are amortized across the duration of acquisition.

The sixth factor is return on investment analysis, which under the two options implies that the buying cost will require a longer time to recover the incurred costs as opposed to leasing. In view of the lean spending environment necessitated by difficult economic environment, this is the best alternative in avoiding tying capital at a time when costs are high (Barkham and Park, 2011). Despite the fact that the relative cost for both options after a long fixed duration of time is higher for a lease agreement, short-term returns on investment are higher in the lease agreement. As an illustration, over the first six months of acquisition through both buying and leasing, the return on investment will be lower for buying when compared to leasing due to the relatively higher initial cost involved.

The seventh factor in favor of the lease is based on the fact that the lease arrangement can partly be funded by the business in which the leased car will be involved. In a lease arrangement, the monthly repayment will only attract a manageable portion of the acquisition cost. In terms of the valuation computation, the depreciated value of the car can be considered for purchasing if the lessee is interested in disposing it off, which is better business based on returns on investment analysis. On the contrary, buying transfers all costs at once to the buyer and it may not be possible to make sufficient returns on investment within a similar duration of time as a lease would.

The other factors of importance in the decision making that favor a lease agreement is the fact that the high interest rates of financing the acquisition can only be expected to drop in the future. It therefore implies that taking a short-term lease agreement then terminating it at the most opportune time is a viable business idea. Additionally, buying the car may not be a viable business idea at the moment due to intense technology that drives future demand for motor vehicle services. As an illustration, the future of motor vehicle business is leaning towards eco-friendly energy consumption and this may affect disposal valuation in future as well as affect demand for the business transport services. Equally, business outsourcing is a market niche that spares the actual purchase of a product due to availability of cheap alternatives. Leases are therefore designed for a better business experience in the modern day business, making it better when compared to purchases in the short run.

Measurements

Assumptions

Assumptions made alongside those indicated above include the acquisition of the car through two possible ways for the same motor vehicle. A different model of car on offer in the lease would change the cost differences significantly.

The immediate need for the acquisition is the business opportunity presented by the CEO of a foreign investment company against the stretched capacity that relaxes at the end of the first two months. If the immediate need appeared at the end of the second month or beyond, it would perhaps not raise the cost benefit analysis considered.

Within the context of the fleet specifications and the needs at hand, it assumed that a lower cost car could not be acquired for replacement with the current units involved in contracts for redeployment to fit in the new investment portfolio needs. This would significantly change the decision patterns considered.

The main costs of consideration do not include other costs such as; incidental costs in the line of business, shipping, legal fees and, consequential costs.

Acquisition Cost Figures

Table 1: Projected cost measurement

Purchasing the Car Leasing the Car for 1 year

Cost $30120 Down Payment (20% of depreciation value) = 1506

Fixed monthly fee + 502

2008.00

Interest rate + 10.00

First month = 2018.00

Total cost of the 1 year lease 64.9+6024+1506= $7594.90

Analysis

Instead of termination of the lease agreement, which would attract high charges of termination, it the best alternative is to go for an entire lease period of one year. At the end of the contract involving the transport cover for the CEO for one year, the cost expected is estimated to be at least $7595 as illustrated in Table 1. Due to the lean operations adopted during the difficult economic times, it is viable to consider the lease which will save (30120-7595) $22,525 in the interim period.

During the same period of time, the lease will have earned the entire contractual fee of $17,340 as indicated in agreement from a monthly pay of $1445. From a business perspective, the book value of the leased car at the end of the first year will be 25% of $30120 (22590). Only a small proportion of the value of the leased car will be required from the earnings made from the lease agreement (17340-7594) 9746, which can easily be financed as opposed to the initial value of $30120. Further computation details are provided in the endnote section contained in Appendix 1.

Summary

In terms of lean spending usually adopted during difficult economic times, the value of the vehicle after the particular contract in contention will be tied in capital. Apparently, the current stretched capacity of operations is likely to be relaxed when the running contracts reach maturity in two months time. Taking the temporal cost element until the maturation of the immediate contract must be considered against the cost of a permanent acquisition. From the need for avoidance of unnecessary costs, it is more advisable to factor in the difficult economic times and save tying up capital up to 30120 while as little as 7594 can be used in the acquisition. (Table 1) Measuring the returns on investment in the short run for the duration of the initial year after acquisition favors the lease option. The assumptions to the effect that the car model in consideration, commencement of the immediate contract, fleet redeployment and the specific acquisition costs must hold true throughout the discourse alongside those contained in the introduction.

Recommendations and Conclusion

Within the context of lean operations, it is difficult to venture into capital spending due to issues such as liquidity and high interest rates that may negatively affect the operations of the business. It is important that alternatives be closely considered in making the final decision for the optimization of returns and benefits and reducing costs incurred. Every business and personal spending decision involving significant amounts of money must be approached from a cost benefit analysis. Determining the returns on investment during difficult economic times may be useful in maintain sustainability in operations.

In the setting of a small company offering VIP transport services, it is important that capital spending be considered for the best acquisition from a number of options (Shilling, 1997). The initial step is the contextualization of the business scenario and available alternatives, which must be conducted within the financial limits of operations. The contextualization must highlight the costs and benefits of each alternative in order to facilitate in the making of the most viable economic decision. Budget constraints may force certain factors to be more feasible in the short run whereas they are expensive in the long run.

References

Barkham, R., & Park, A. U. (2011). “Lease versus Buy Decision for Corporate Real Estate in the UK,” Journal of Corporate Real Estate, 13 (3):157-168

Bishop, J. (2011). “Lease vs Buy- Financing IT Asset Acquisitions,” Retrieved from: HYPERLINK “http://blog.thehigheredcio.com/2011/08/19/lease-vs-buy-financing-it-asset-acquisitions/” http://blog.thehigheredcio.com/2011/08/19/lease-vs-buy-financing-it-asset-acquisitions/

Shilling, J. D., (1997). “Economic Forces Shaping Investment in Office Markets,” Journal of Property Finance, 8(4):283-302

Appendix 1

End Notes