The net advantage to leasing is a calculation to determine the benefit gained from leasing an item over making a direct purchase. While this concept can apply to both individuals and businesses, its most common use is facilities or equipment purchases made by businesses. Net present value is a basic finance companies will use to determine the net advantage to leasing versus a direct purchase. Net present value compares the future cash flows from each option against the present cash outflows need to lease or buy the item.
To calculate the net present value, business owners and managers will need to start by estimating the future cash inflows generated by the new item. In some cases, these inflows may be the same under the lease or purchase option. However, companies may get a higher quality item under a lease rather than a purchase, since leasing may allow the company to obtain a better quality item for less money. To complete the first half of the formula, business owners and managers will discount the cash flows using a return-on-investment formula and add up the total of these figures.
The second half of the net present value formula to determine the net advantage to leasing is calculating all the costs associated with leasing or purchasing the item. Costs will include cost of items, sales tax, shipping or freight expense, installation fees and wages for employees setting up the item, among other items. To calculate the net present value, deduct the total current cash outflows from the total discounted cash inflows. A net advantage to leasing will mean that the future cash inflows from leasing the item will be higher than the net present calculation from purchasing the item.
Companies will lease equipment if they will gain a non-financial net advantage to leasing. For example, business technology equipment or applications often become outdated very quickly, meaning the company will need to upgrade or replace these items. Additionally, maintenance fees or other corrective measures may cost more money if the company purchases an item. Under a lease agreement, the supplier of the item will often repair or correct issues at their own cost, since they still own the item.
Lease may also allow the company to either purchase the item at the end of the lease or exchange it at low or no extra costs. This helps the company to have a strategy in place for advancing its operations through planned upgrades — another net advantage to leasing.