Leasing or Owning Equipment - Term Paper Example

A decision on whether to own or lease a particular piece of hospital equipment would have to take into account many factors. The most obvious is the cost of the equipment. In the given scenario, the cost to buy is $75,000. Needless to say that this is a considerable sum of money to pay outright and therefore there is an alternative consideration at hand whether to lease the equipment for five years.

The lease rental is $ 11,000 per year, for five years. Depreciation is one factor that needs to be considered as well as it would reduce the value of the equipment. Another factor would be revenues and the number of people using that equipment. In an operating lease, the lessor would bear the cost of a reduction in the value of the asset, but in the case of a capital lease, this would be transferred to the lessee. A lease is considered to be a capital lease if (a) the terms of lease contain a bargain price option, (b) the lease term is equal to 75% or more of the estimated useful life of the asset, (c) the present value of the minimum lease payments amounts to 90% or more of the fair value of the leased asset, and (d) the lease transfers ownership of the asset to the user at the end of the lease term (Meigs & Meigs, 1993).

We are told nothing about (a) or (d) but can calculate (b) and (c). Let us start by assuming that we buy the equipment and that it is being fully depreciated on a five-year life term. As per the data given, the depreciation schedule will be as under Year Depr Exp Accum Depr Book Value1 Purchase Price 75,000 2 Annual Depr- Year 1 0 0 75,0003 Annual Depr- Year 2 10,000 10,000 65,0004 Annual Depr- Year 3 10,000 20,000 55,0005 Annual Depr- Year 4 10,000 30,000 45,000We are told nothing about the discount rate to use here to calculate the present value of the lease rentals.

However if we assume a discount rate of 10 percent, the present value of the lease rentals will be as under:Year Rental Present Value @ 10% 1 11,000 11000/1.10 = 10,000.002 11,000 11000/1.21 = 9,090.903 11,000 11000/1.331 = 8,264.464 11,000 11000/1.4641= 7,513.145 11,000 11000/1.61051= 6,830.13Total Present Value of 5 Year Rental = $41,698.63This calculated present value is more than 90 percent of the depreciated value of the equipment as at year 5. Ninety percent of the depreciated value of the equipment amounts to $40,500 in year 5.

So it is definitely a Capital Lease. In the current circumstances, it would be better to buy the equipment rather than to lease it. This is because the salvage value of the equipment at the end of the leased term stands at $45,000, compared to the $41,698 of the present value of the leased payments. Conclusion Leasing or owning equipment can be a major decision in a hospital environment. Comparing the net present value of inflows and outflows can be useful in making a final decision.