Amg/Forsythe: Lease vs. Buy
AMG/Forsythe: Lease vs. Buy
AMG Inc, a Fortune 500 financial services company, is implementing 7,542 new PCs in the time frame of twelve months in multiple locations covering eight states. This is a $7.5 million technology financing decision which needs to be investigated. The current decision that Adam Stolz, controller for the CFO, faces is whether AMG should lease or buy the new PCs. Also, he is under pressure from the CEO to keep the transaction off of the balance sheet, in which case the equipment/software would have to be defined as an operating lease, according to the standards defined in FAS 13. The lease options consist of a 24-month lease or a 36-month lease, and AMG could also choose to purchase the computers for the same lengths of time.
In order to identify and document the financial strengths and weaknesses of each option, our team has forecasted the NPV for each scenario, including the lease versus buy for each term length. First, we calculate the NPV of purchasing all 7,542 computers and their software for 24 months at $750 and $250, respectively. This therefore requires an initial investment of $ 7,542,000. Based on the different provisions required by U.S. government tax code, hardware will be depreciated under 5 years’ MACRS depreciation method and software will be depreciated to zero in five years under straight-line depreciation method. Thus, the book value for hardware is $2,715,120 in year 2 and the book value for software is $1,131,300. Stolz estimates that a $750 PC will be worth approximately $150 in 24 months, for a before-tax salvage value of hardware of $1,131,300. Considering the loss on book value, this provides an after-tax salvage value of $1,669,799. Software has no salvage value regardless of the year, so AMG will have a total loss equal to the book value. This in turn provides AMG with a tax benefit of $923,141. The after-tax salvage value of the hardware and software will therefore be $2,054,441. After
AMG Inc, a Fortune 500 financial services company, is implementing 7,542 new PCs in the time frame of twelve months in multiple locations covering eight states. This is a $7.5 million technology financing decision which needs to be investigated. The current decision that Adam Stolz, controller for the CFO, faces is whether AMG should lease or buy the new PCs. Also, he is under pressure from the CEO to keep the transaction off of the balance sheet, in which case the equipment/software would have to be defined as an operating lease, according to the standards defined in FAS 13. The lease options consist of a 24-month lease or a 36-month lease, and AMG could also choose to purchase the computers for the same lengths of time.
In order to identify and document the financial strengths and weaknesses of each option, our team has forecasted the NPV for each scenario, including the lease versus buy for each term length. First, we calculate the NPV of purchasing all 7,542 computers and their software for 24 months at $750 and $250, respectively. This therefore requires an initial investment of $ 7,542,000. Based on the different provisions required by U.S. government tax code, hardware will be depreciated under 5 years’ MACRS depreciation method and software will be depreciated to zero in five years under straight-line depreciation method. Thus, the book value for hardware is $2,715,120 in year 2 and the book value for software is $1,131,300. Stolz estimates that a $750 PC will be worth approximately $150 in 24 months, for a before-tax salvage value of hardware of $1,131,300. Considering the loss on book value, this provides an after-tax salvage value of $1,669,799. Software has no salvage value regardless of the year, so AMG will have a total loss equal to the book value. This in turn provides AMG with a tax benefit of $923,141. The after-tax salvage value of the hardware and software will therefore be $2,054,441. After