To BUy or Not to Buy- Lease vs. Buy Decisions

Essay by jah_rule24 March 2006

download word file, 3 pages 4.3

During the course of Week 2 in Finance 325 students were asked to complete a simulation titled "Analyzing Lease vs. Buy Decisions." Bonnesante Research is a strong biotech start-up based in Irvine, California. Bonnesante is trying to tap into the very profitable anti-infective drug segment of the pharmaceutical market. In order to do so Bonnesante requires additional capital purchases over a 6-7 year period. Acting as the firm's Chief Financial Officer (CFO) students were tasked with selecting the optimal mode of financing the company's acquisitions. This simulation was divided into three parts and required students to determine which financing options would be the preferred method of purchase for the mainframe computer, spectrometer, and production facility. Students were asked to consider Capital Leases, Operational Leases, and outright purchasing while also taking into consideration financial pitfalls and regulatory issues.

The first step in the simulation required the CFO to evaluate the lease and buy options pertaining to the firm's need of a mainframe computer.

The Chief Financial Officer must pay careful attention to the option with the lowest present cash value. The initial cost of the mainframe is $650,000. Purchasing the mainframe is not an option due to the depreciation and continued influx of new technology. The optimal method for the acquisition of the mainframe was determined to be an operating lease. This was chosen because Bonnesante is unlikely to use the computer through its entire economic life. The tax implications are not applicable since Bonnesante Research is not taxed.

The second phase of the simulation asks the CFO to consider the lease verses buy options for an advanced digital spectrometer. This is very expensive equipment with an asking price of approximately $2,000,000. The CFO entertained the idea of a short-term Operating Lease, a longer term Capital Lease, and a...