Financial Management: Lease vs. Purchase Analysis - Canada Hardware

This case study analyzes the financial decision of whether to lease or purchase new manufacturing equipment for Canada Hardware. It begins by explaining the advantages and disadvantages of leasing from both the lessor and lessee perspectives, considering factors such as cash flow, tax benefits, and risk of obsolescence. The study then calculates the weighted average cost of capital (WACC) and uses it to perform a Net Advantage to Leasing (NAL) analysis. Additionally, it examines the impacts of sensitivity analysis, including changes in lease payments, salvage value, and security deposits. The analysis concludes with an evaluation of whether the investment should be purchased or leased under different scenarios, determining the lease classification and its effect on the statement of financial position, including the implications for Mr. Stark's tax burden and the overall financial position of the enterprise. The Enterprise should opt for the Capital lease option because it is cheaper and has tax benefits.

Running head : FINANCIAL MANAGEMENT
FINANCIAL MANAGEMENT
Name of the Student
Name of the University
Author Note

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Table of Contents
Answer to question 2..................................................................................................................2
Advantages of Leasing...............................................................................................................2
Disadvantages of Leasing..........................................................................................................2
Answer to Question 6.................................................................................................................3
References..................................................................................................................................5

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Answer to question 2
Leasing: Financial leasing is a kind of leasing, in which a company relating to finance is
certainly the legal owner of the asset for the time span of the lease. Financial lease includes
two parties, namely the lesser and the lessee (Starodubtseva, A. 2017). The lessee has an
operating control over the asset and it bears some economic risks and returns from the change
in the valuation of the underlying asset.
Advantages of Leasing
Lease financing has the following advantages:
 Balanced cash outflow: One of the greatest advantages of lease financing is that
payments or cash outflow related to the lease are being carried on through several
years. (Devereux, M. P., & Liu, L. 2015, January).
 Tax Benefits: The lease financing is referred to as an operating expenses, which
when reflected in the profit and loss account of the proprietor can reduce the tax
liability of the proprietor (Fatoki, O. 2015).
 Reduces the risk of obsolescence: For the businesses which are operating in the
sectors of high technology obsolescence risk, lease financing is a sector which reduce
such risk of obsolescence as there is not a chance to invest to in the company.
Disadvantages of Leasing
Lease financing bears the following demerits:
 Lease expenses: Lease expenses ,might reduce the tax burden of the [proprietor, but
at the same time the it increases the operating costs of the proprietor, which at times
exceeds the cost of investment in a particular asset on a long run.

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 Reduces the access to other loans: Since lease is considered as a debt by the
investors, it reduces the access to take more loans.(Kholodilova, A. 2018).
 Complex Procedure: entering into a lease financing is quite a complex process and it
requires thorough documentation and proper examination of the asset that is to be
leased.
 Limited tax benefits: Lease financing does not provide adequate tax benefit to the
start up businesses.
To conclude, lease financing is appropriate for the companies, for which it is it possible
for raising capital through other sources, like term loans or debts due to shortage of funds.
Reason for the lessor to lease
 Assured regular income
 Preservation of ownership
 Tax Benefits
 Increased profitability
 Enhancement of growth potential
 Recovery of investment
Reason for the lessee to lease
 Use of capital goods
 Tax benefits
 Economies of scale
 Technical assistance
 Inflation Friendly

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Answer to Question 6
The Enterprise should opt for the Capital lease option because it has the following
reasons
 Cheaper: If the enterprise opts for capital leasing then it would not have to pay cash
on the early place. The rate of interest in the capital lease is relatively cheaper,
compared to other options.
 Claim to Depreciation: The capital lease involves the transfer of ownership rights to
the lessee, the asset can be shown in their balance sheet and depreciation on the same
can be claimed. Depreciation, being an expense would reduce the profit of the
company, which in turn would tax burden of the company.
 Claim to Interest expense: The lessee does not pay for the asset, the payment for
which is done by the lessor. The lessor pays the interest on the capital which it
charges to its lessee. The interest so paid is an operating expense, which would reduce
the profit as well as the tax liability of the business (Porter, J. C. 2016).
Impact on Financial Statements
If the enterprise opts for the capital lease option, it would have certain benefits
relating to the tax. If the company shows the depreciation in the balance sheet, then it can
claim for depreciation, which would lead to its profits being reduced, and therefore the tax
burden would be reduced. The same goes with the interest that is to be paid for the asset. It
will also reduce the tax burden for Mr. Stark. The effect on financial position would be that
their profits might reduce, but the tax burden will also reduce. However, the profit so reduced
will be lesser in comparison to the tax burden so reduced (Glotova, I. I., Tomilina, et al.,
2016).

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References
Devereux, M. P., & Liu, L. (2015, January). Incorporation for investment. In Proceedings.
Annual Conference on Taxation and Minutes of the Annual Meeting of the National
Tax Association (Vol. 108, pp. 1-52). National Tax Association.
Fatoki, O. (2015). The effect of human and social capital on the knowledge of financing
alternatives by new small business owners in South Africa. Corporate Ownership and
Control, 13(1), 840-856.
Glotova, I. I., Tomilina, E. P., Uglitskikh, O. N., Klishina, Y. E., & Kosova, T. Y. V. (2016).
Homogeneity Assessment of the Leasing Portfolio and Segmentation of Leaseholders
for Identifying Risk Concentrations. International Journal of Environmental and
Science Education.
Kholodilova, A. (2018). MODERN GOVERNMENTAL INSTRUMENT LEASING
ACTIVITIES. BIOLOGICAL SCIENCES, 15, 24.
Porter, J. C. (2016). A Refresher on Accounting for Leases: A Detailed Example under the
Proposed Guidance. The CPA Journal, 86(1), 24.

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Starodubtseva, A. (2017). Leasing as the means of equipment financing: Comprehensive
assessment.