Net Advantage to Leasing (NAL)
What it is:
How it works (Example):
Under a lease agreement, the user (the lessee) agrees to make periodic payments to the owner (the lessor) in exchange for the use of the asset. In general, the lessee will only consider leasing the asset if the sum of the lease payments is less than the cost of buying the asset outright. To determine if there is a net advantage to leasing an asset, simply compare the net present value (NPV) of purchasing to the net present value of leasing.
For example, let's assume Company XYZ needs a MegaWidget for its factory. Company XYZ can purchase a MegaWidget for $100,000. Alternatively, Company XYZ could lease a MegaWidget from Company ABC for $24,000 a year. What should Company XYZ do?
The answer is "it depends." Ownership and leasing both provide unique advantages and disadvantages that might or might not work for Company XYZ.
For example, if Company XYZ buys the MegaWidget, it can record a depreciation expense each year -- but lessees cannot. Depreciation can lead to lower taxable net income. But owners are also responsible for repairs, maintenance and property taxes on their assets -- while lessees may or may not be, depending on the agreement.
Why it Matters:
Companies are frequently faced with the decision whether to purchase or lease machinery, equipment, real estate, and other assets. The right choice can have a major impact on a company's cash position and financial stability.
Having access to the assets is almost always more important to a company than whose name is on the deed or title, though sometimes the tax advantage of asset ownership is more persuasive. And sometimes a company has little choice but to lease if it cannot obtain the cash or financing to purchase the asset.
As a result, there is no surefire way to calculate whether leasing is better than buying when it comes to specific companies and assets. That said, the ability to make buy/lease recommendations that ultimately increase shareholder value is the mark of a talented CFO.