Charity organisation wants a new laptop cost £1102.00. Company who maintains our IT sent a quote for cash purchase or 3 year rental plan. Director wants to know whether or not it will be of benefit to us to rent. Personally I think not but if someone could look at these figures and confirm my thoughts, or otherwise, I'd be grateful.
The Rental comparison v Cash purchase assumes Corporation Tax at 21%, Return on Capital Employed 15% and a Discount Rate of 10%.
As a non-profit making charity we would not benefit from the corporation tax element.
These are their figures:
Rental £1408.32 Tax saving £295.74 Net Rental cost £1112.85 NPV 998.76 Total Cost £998.76
Capital cost £1102.00 Tax Saving £112.93 Net Capital cost £989.07
NPV of Net Capital Cost 1006.31 NPV of Opportunity Cost 215.64 Total Cost £1221.95 (cash tied up in asset)
Saving using leasing £233.19
As I say I don't see it myself but what doe others think (Rob, Shaun????)
Sorry Sheila, not really something I know much about (I had to look up npv!). My gut feelings are:
you can prove anything with statistics (is 10% a reasonable discount rate, the opportunity cost of not having the cash could be much lower if it was only going to sit in a low interest bearing bank account).
At the end of the rental does the laptop belong to the charity?
But my main concern is that is a lot of money for a laptop!
Ah Rob, it's a lot of money 'cos it's a Mac. All the 'puters there are Macs, they had to get parallels for me so I could use Sage.
My own feeling is buying would be better. The comparison does not make it clear whether or not we get to keep the lapdog at the end of the 3 year lease but I suspect we probably would because what would they do with it, it wouldn't be worth much. Irrespective I still think buying is best. Not sure about the 10% discount or what it is but we wouldn't benefit from the corp tax 21% and our surplus of unemployed money at the moment is in a low interest bearing notice account.
it's pretty clear that this is a finance rather than an operating lease as substantially all of the benefits of the asset will be consumed during the life of the lease.
As such even if the computer is leased it still needs to appear on the balance sheet and be depreciated over it's useful economic life... sorry, habbit. I know that you know that.
Providing that all assets of the same classification are treated the same you should be able to capitalise the interest element of the charges as part of the initial purchase (if you wanted to).
Unfortunately I'm in a hotel and my books are all 283 miles away otherwise I would have a look through all of the various obtions.
I'm always adverse to giving technical advice when I've not got my eight billy bookcases of safety net to hand!
I'll be home again tomorrow night. If you can wait until then I'll go through the figures in a bit more detail.
Gut feel though would be to go for purchase but don't quote me on that until I've had a proper look at the options.
Really nice to see NPV, opportunity costs and discount factors getting a mention on here. Sounds as though your turning into a closet management accountant Sheila.
__________________
Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
The IT people called it rental at the beginning then lease at the end. Mainly because of our not paying corp tax because we are non-profit making I believe we won't benefit from the tax savings indicated.
Director away until next week anyway so if you have time to have a look I'd be grateful as I'd rather speak from some knowledge rather than my own gut feeling. But don't spend time on it to the detriment of spending time with your son over the weekend.
Me, closet management accountant, nah - it's years and years since I've messed about with stuff like that.
Thanks Shaun.
-- Edited by semsley on Thursday 1st of July 2010 08:56:22 PM
I've got a few mins so lets take a closer look at this scenario.
#1 reverses lost interest so that the variance is added to the purchase price. #2 reverses the depreciation variance to allow for the time cost of the money tied up in the purchase.
For purchase this would normally have been AIAd for 100% first year capital allowances but in connection with your line about no benefit being derived from the corporation tax element Ill leave that out of the equation.
However, even though AIAd the depreciation will still be over the three years so the NPVs of depreciation are shown for each period.
This of course means that for an outright purchase in year 0 at a discount factor of 10% would return over a three year period a return in real terms of £188.81 less than the investment. Then again, as depreciation is added back before tax is calculated such is not really a consideration for us here.
More importantly as you suggest is the opportunity cost of the income tied up in the purchase. The interest on this when compared against the money that would have been spent leasing the computer when taking into account the NPV is £40.57 over the comparable period.
Note that I calculated the NPV on the lost interest rather than calculating NPV on the Opportunity cost as that just seemed wrong.
Removing from this the variance on the depreciation over the period to allow for the time cost of capital we come to a more comparative figure or £953.76 for actual cost of purchase.
CONCLUSION
So, overall, excluding tax from the calculations the real comparisons would be between a leasing NPV of £1,095.07 (which takes into account the NPV of the lease payments less the NPV of additional interest on the opportunity cost) with a somewhat contrived figure of £953.76 for outright purchase.
On the face of matters and assuming that all rates remain constant over the period then purchase would seem to be the better option.
However, all of the above does not consider tax implications due to such not being required as part of this exercise.
As with all statistics there are many other ways of looking at the figures.
For example, (using 10k as a complete guess as to current assets employed and applying 15% ROCE as suggested in your original post) making the investment may adjust the return on investment of your client. Take a look at these figures which quite rightly show that the computer will not make any difference to the actual return :
So as you can see the ROI would fall from 15% to 13.51%
Using Residual Income rather than ROI would yield the following results :
So under both ROI and RI the return would be less by investing in the new computer and in purely practical terms there would be no reason to buy it unless the current income would fall without it. (Doubtful).
Of course, we all know that ROI is not the only reason for purchases of this nature.
ROI and RI look at matters only in purely financial terms and do not in this instance take into account any increases in efficiency which would be difficult to substantiate.
Hope that I've helped rather than just confussed matter further,
All the best,
Shaun.
P.S. I'll just keep my fingers crossed that this is all readable when it gets posted!
P.S.2 Well, it lost two of the inserts and filled the doc with XML tags at first post. Lets see how this attempt goes.
P.S.3 I made a mistake in my original posting and used the purchase price as the opportunity cost rather than the difference between the purchase cost and the rentals to date. (must remember, less haste, more speed!).
-- Edited by Shamus on Saturday 3rd of July 2010 12:48:05 PM
__________________
Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
As an addendum to the above, a lease generally incorporates a warranty. Does the figure of £1102 also include a warranty as that could tip the preference in the opposite direction.
Also, there's argument to suggest that considering the NPV of depreciation in the purchase argument is too contrived and without this the lease option is again the more appealing option.
I really think that for the difference as calculated the figures are not sufficient to override personal preference as to how the purchase should be funded.
__________________
Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
