1. Executive Summary
Ben’s Joinery is a privately owned company that is located in Barking, United Kingdom. The company has an estimated annual income of $147,712 and employs a staff of about 2 people. The company is seeking to acquire a CNC miller machine however the management of the company has not made a decision whether to buy the machine or lease it. There are several considerations that need to be made when determining the right course of action. This analysis uses several financial statement documents to determine the viability of any decision to be made (whether to purchase or lease). The financial statement takes into consideration the initial purchasing cost and the maintenance cost and then compares it with the taxes, amount paid for leasing and other incurring costs. Based on the comparison, a report is drawn on whether to purchase the machine or lease it.
Leasing involves a contractual agreement between the lessee and the lessor whereby both parties have some limited rights over the use of the property. The lessor could be the property manufacturer or an independent institution that is charged with the responsibility of taking care of the property. The lessee on the other hand pays for the use of the property at some agreed on rates. There are several reasons why a firm may consider leasing to buying of a product. Either way, the firm will have to incur some costs for using the product. The costs can be either incurred through purchasing the item or through paying for the services rendered by the item. The lessor is usually required to incur the maintenance costs of the item. The lessee will only be after the services offered by the item during the period which the contract is running. In this project we are going to look at the cash flows of leases and make a decision as to whether the company should consider leasing the machine or buying the machine. Companies prefer leasing equipments to buying due to a number of reasons especially those ones based on the amount of costs involved.
3. Problem definition
Ben’s Joinery wants to acquire a CNC milling machine so as to help them in their operations. However the company is caught in between deciding whether to buy or lease the machine. An analysis was therefore commissioned by the Company’s boss to determine which cause of action needs to be taken.
The objectives of this research are:
i. Determine whether the company should buy or lease the CNC milling machine
ii. Provide a financial state of art analysis and give a summary of the company’s financial stand.
There are several methods of data collection approaches that were used by the company so as to come up with the final conclusion. Most of the data used for the research were obtained from the financial statements of the company for the latest years. It was possible to predict the future performance of the company using the available data. The data collection method that was used for the study was mainly quantitative that involved a thorough analysis of the company’s financial statements. The data collected from the company’s financial statements were then analyzed and calculations of the Net present value calculated using the available data to determine whether the company was to purchase or lease the milling machine. All the tables used in the calculations section were obtained from the company’s financial statements presented in the accompanying excel workbook.
The following table shows the variable data that was used to determine whether it was more appropriate for Ben’s joinery to buy or lease the CNC milling machine
If Ben’s Joinery Company chooses to lease the machine, it will save $ 10,000. This is the amount of money the company could have used to purchase the machine. The amount shows up as the initial cash flow in the first year of leasing. Once Ben’s Joinery decides to lease the machine, it will have to give up all the depreciation tax benefits associated with the machine. This lost tax benefits will show up as cash outflow.
The depreciation rate of the machine is 20% reducing balance. The depreciable base is $10,000 and the tax rate is 28%. The depreciation per year is calculated as shown above in table 1. The leasing duration is assumed to be five years after which the asset is perceived to have no value. Therefore the tax benefit from depreciation is 28% of the $ 4,096 which is equivalent to $1,146.88
The above table was prepared to show the direct cash flow consequences of buying the CNC milling machine and the consequences of signing for a lease. From the data presented above, Bens Joinery will save up to $3,960 from the use of the CNC milling Machine whether the machine is leased or bought by the company.
If the company leases the machine, it would save $10,000. This is the amount of money that could have been used for purchasing the machine. The saving shows up as the initial cost in the year 2010 (also known as year 0). However if Bens joinery decides to lease the machine, it will no longer be able to own the machine and therefore it will have to give up all the depreciation tax benefits. The lost tax benefits are shown in the statement as outflows.
If ben’s joinery decides to lease the machine, it will have to pay $2,500 per year for a period of five years (from 2011 to 2015). The lease payments attract a tax benefit of $700. This amount is calculated as shown below:
Lease payment – Tax benefit + the lost depreciation tax benefit.
The amount payable every year is computed in the above table using the above formula.
In order to make a fair decision on which step should be taken (leasing or buying), the flows should be properly discounted. The cash flows in the lease versus buy decision should be discounted at the after tax interest so as to give a clearer and a better view of the scenario.
The best method to determine whether any given set of decision is viable or not involves discounting all cash flows at the after-tax interest. In our case we are going to make an assumption that Ben’s Joinery can lend the Milling machine at an interest rate of 7.85% (from the data in the variables table). In this case, the corporate tax rate is 28%.
7. Analysis of the results
The results obtained from the calculations clearly show that leasing the machine is a better decision. Several results were computed so as to determine the company’s financial statement. A positive NPV value shows that leasing an item is better than buying the item. The calculations performed in chapter 6 were aimed at determining several variables and the way they influenced the leasing/ buying project. It can also be established from the results that the costs involved in changing the ownership of an asset are relatively higher than the costs involved in leasing the item as shown in the above calculations made.
According to the information obtained in Chapter 6, lease arrangements are preferred to buying the machines. The data provided by the company was analyzed and it returned a positive value for the Net present Value thus showing that the lease arrangement is a better option. Some of the reasons why companies may seek to lease machines instead of buying them include reducing taxes and reducing some kinds of uncertainty. Companies also prefer leasing to buying since some of the transactions costs incurred when buying are usually higher than the costs incurred when an item is leased. Ben’s Joinery reported a positive NPV value implying that leasing the machine was better than buying the machine for the company.
9. Integral Total Management
Explain why it is important to do an analysis in Finance. Refer to other important management departments. Say why these departments have advantages when the company had made an analysis of a new purchase.
Financial analyses are very essential in any business set-up. They help in giving the historical information about the stand of the company. Several companies carry out financial statements analysis so as to determine the company’s performance and also help in predicting the future performance of the company. The financial analysis also help to determine whether a given company is making any progress in its operations or it is lagging behind in terms of operations. There are several departments that benefit as a result of a comprehensive financial analysis especially when a new purchase is to be made:
i. General economics
A comprehensive financial analysis will help this department to ensure that the best deal is reached when purchasing a new item for the company. This department is charged with the responsibility of ensuring that that there is proper utilization of resources in the firm. Financial analysis will help the department achieve its goals of reducing expenditure and maximizing on the income of the firm.
The marketing department is charged with the responsibility of ensuring that proper marketing strategies are put in place. A comprehensive financial analysis will help the department to achieve its goals effectively as marketing an item that has been well analyzed is much easier than marketing an item that the users are not quite familiar with its uses and advantages.
iii. Financial Management
A comprehensive financial analysis will help this department achieve its goals and objectives effectively since it is the department that is concerned with determining the amount of money spent for all the activities of the company. Carrying out a comprehensive financial analysis will ensure that there is no wastage of resources when a new purchase is made and that the best possible offer is adopted thus ensuring maximum utilization of the company’s resources.
iv. Strategic Management
The strategic management department helps the company to formulate strategies that can help the company in achieving its objectives. A comprehensive financial analysis will help this department achieve its goals more easily as it can easily determine whether the new purchase is viable and more productive than using the older item in the company.
The human resource department will benefit when a comprehensive financial analysis is made before making a new purchases as the users will be familiarized with the new purchase and its benefits and constraints properly outlined. This will help the department reduce the amount of resources it could have spent carrying out training on the users and implementing a product that may have operational constraints.
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