Comparing the Economics

April 13, 2006

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The main advantage of leasing a business facility is that your initial outlay of cash to gain the use of an asset is generally less for leasing than it is for purchasing. However, perhaps the main advantage of purchasing is that you end up paying out less in the long term than you would have paid if you leased the facility. Moreover, if you purchase, you get the benefit of any appreciation in the value of the property.

How do you reconcile these factors? One way is to do a mathematical analysis of your net cash flows that would result from leasing and from purchasing.

A cash flow analysis provides an estimate of how much cash you would need to set aside today to cover the after-tax costs of each facility acquisition alternative. To perform the analysis, you need to know or assume certain facts, including:

purchase and financing terms, including closing costs
lease terms
your combined federal and state income tax rate
the facility's expected useful life to your business, for depreciation purposes
the asset's estimated value, when you sell it, or at the end of its useful life to your business
your cost of capital
any other costs that you would incur if you leased the facility but not if you purchased it, or vice versa (for example, you'd need to account for expected maintenance costs if the landlord was assuming responsibility for those costs)

From a financial standpoint, there are a number of ways to evaluate the wisdom of a major purchase or project. For a detailed explanation of the subject, see our discussion of major purchases and projects.