As an alternative to the borrow-and-buy plan, the equipment manufacturer informed Lewis that Consolidated Leasing would be willing to write a 4-year guideline lease on the equipment, including maintenance, for payments
Lewis Securities Inc. has decided to acquire a new market data and quotation system for its Richmond home office. The system receives current market prices and other information from several online data services and then either displays the information on a screen or stores it for later retrieval by the firm’s brokers. The system also permits customers to call up current quotes on terminals in the lobby.
The residual value of the equipment will be recorded in the books of the owner and he/she has to bear the high risks of residual value.
The uncertainty of the residual value is adjusted in the agreement through increasing the discount rate, high discounting rate in turn decreases the present values of the residual value and other cash flows which are treated as cash inflows while determining the cost of owning the equipment.
The lower cash inflows will definitely increase the cost of owning the equipment and make the leasing more attractive.
In a case where the lessee acquires the asset after the end of lease agreement, the residual value of equipment is considered in calculating the cost of leasing in the books of the lessee.
In the concerned case, if the company purchases the equipment, the company has to bear the uncertainty of residual value. The risk is adjusted by increasing the discount rate which decreases the present value of equipment's residual value. The residual value is treated as an inflow while calculating the cost of owning and therefore, the lower residual value will increase the cost of owning the equipment. Thus, leasing the equipment will become favourable over owning it.