The transportation business in Malawi is in a conducive environment due to the enormous dependency on road networks only for the transportation of goods. The railway line and the water transports not yet developed so as a result much of the large operations are done by road. Malimbe Company Ltd is one of the transportation companies involved in the business; however, due to this vast opportunities, there is an excellent competition from other international companies.
It is therefore ideal that the management of the Malimbe company Ltd has to re-think and revisit their strategy or risk losing customers and the overall business to other competitors. In order to avoid such, there is a proposal for obtaining a new fleet of vehicles to boost their transportation business. However, the dilemma comes in the two options of whether to lease or buy the new vehicles and with the current poor cash flow, the best cost effective with maximum productivity option ought to be followed. Malimbe Company Ltd, as a result, hired the author to give the best advice on how best they can analyse the elements or factors before considered whether to lease or buy the fleet vehicles.
By efficiently leveraging the accessible information, not only will the corporation recognise which vehicles are costing them the most but also why they cost the most. Will the leasing situation inflate costs for the reason that the business is not cycling them out of service at the appropriate time? Is procuring vehicles limiting the cash flow of the organisation, adversely impacting other core parts of the company? By taking the time to implement an in-depth analysis and inquire the fair questions, the corporation will achieve clarity and guarantee they are creating significant business choices based on accurate data reinforced by historical statistics, not just instinct or approximations. A comprehensive assessment constructs ethical decision-making and deducing the correct information is central to the development (Bhattacharya, H. 2001).
The primary assumption in this case study is that the running expenses seem not to affect either of the two options as this type of investment, as Malimbe Company Ltd will still meet the operating costs of the assets regardless of the leasing or buying option. Expenses and Insurance shall not differ between the alternatives. However, there are other factors which vary significantly between the two options as shall be expressed in the preceding chapters.
2. Factors considered before Leasing Option
Upon obtaining new fleet vehicles, there are numerous significant elements that Malimbe Company Ltd should always take into account, but perhaps the essential one is how the requirements of the fleet affiliate with—and reinforce —the whole aim of their company. Creating a comprehensive procurement strategy commences with defining how these assets will add to the achievement and development of the company. Once they have established how the fleet will line up with and help their corporation, here are some little extra elements to contemplate before embarking on the leasing option as follows:
2.1. Factor 1: the appraisal method or cost of capital comparison
It is an exploration of what the corporation will acquire for their capital investment
a. Buy: Buying creates full possession without limitations on the vehicle’s usage.
b. Lease: while leasing, the lone payment required is the percentage of the vehicle’s depreciation that’s anticipated to increase throughout the life of the lease—usually 2 to 5 years (Brealey R. A., Myers S. C., Allen F 2006).
c. Assessing the choices: It is best to understand that leasing might give rise to the ownership in that the corporation may be able to acquire the assets at the end of the lease for a smaller amount of cash than they would have to buy.
For example, supposing “Stansfield Motors Malawi” sells the Vehicle trucks required trading for $25,000 to their clients. One option is that Malimbe Company Ltd purchases one of the trucks for $25,000 and the other alternative is that they lease the truck for four years with a possibility to buy for $7,000 at the end of the lease. Assuming that the truck’s fair market value would be $11,000 at the end of the lease, it implies Malimbe Company Ltd establishes lease expenses on $14,000 ($25,000 – $11,000) which turns out that the each of the cars is necessarily worth $14,000 at lease end. Therefore, it is viable that Malimbe Company Ltd applies the lease option for the reason that they possibly would have given $25,000 to buy the truck. However, in its place, they shall give $21,000 ($14,000 lease payments + $7,000 option) to gain the same truck on the lease option.
2.2. Factor 2: What the company pays up front
a. Buy: When purchasing the trucks, the Malimbe company ought to source a large portion of the up-front money, as well as a down payment (or full cash price) together with Sales and other taxes, insurance and lender expenses.
b. Lease: Malimbe Company Ltd will disburse a smaller amount of money up-front when they lease, together with expenses for capitalised cost reductions, taxes, Insurance or lesser charges. Initial once-a-month payment and refundable security deposit.
c. Assessing the choices: Leasing is a suitable option if the company has cash flow difficulties or better expenditures for their money (for instance the prospect to utilise the money for other investments with a higher return). The cash trade-off is not continuously simple but sometimes complex. Consequently, Malimbe company might profit by merely creating a more substantial down payment on the lease to acquire a lesser periodic lease expense.
2.3. Factor 3: Cash Flow Earning Capability
Leasing may advance Malimbe’s company’s cash flow when contrasted to a term loan or cash choice. The most important advantage is that leasing liberates working capital to utilise in other circumstances — to nurture the business or to spend on advertising or research, for instance. When a Malimbe company Ltd leases, it can attain machinery and get it fitted with least original cost. Buying, in contrast, needs a substantial expense of money: Usually, a company might only fund up to 80 per cent of the procurement expense or hard costs. In short, leasing may permit Malimbe company Ltd to acquire more expensive equipment than what it possibly affords.
a. Buy: Once-a-month expenses are higher on purchases for the reason that the company is indebted to pay the whole acquisition charge of the truck in addition to sales taxes, interest, license fees, personal property and insurance.
b. Lease: Monthly lease payments are minor since the corporation shall pay for only the depreciation of the trucks over the lease term plus rent and taxes.
c. Assessing the choices: Because lease payments are lesser than monthly buying payments, the corporation can manage to pay for pricier, more magnificent performance automobiles by leasing option. The same $500 per month that get Toyota Freightliner if they purchase might be enough to lease a higher Mercedes Model.
2.4. Factor 4: What the company pays in non-tax depreciation
Non-tax depreciation (that is; erosion of the vehicle’s fair market value for the duration of the period it is being utilised) is a cost of both buying and leasing, incorporated into the corporation’s taxes in the manner of deductions and loss on sale (if the enterprise owns the vehicle).
a. Buy: The drop in value from the period of acquisition to the phase of sale is a cost that increases to or deducts from the business’s pocketbook. However, there is a probability that the corporation may oversee non-tax depreciation and residual value when purchasing vehicles (Cressy, R. 1996).
b. Lease: A lease shall be fundamentally a bet between Malimbe Company Ltd and the lessor on non-tax depreciation and its outcome on the buying price choice at the end of the contract. In this lease, the corporation will know in advance how much they can purchase the trucks for at the end of the lease.
c. Weighing the options: It is significant to be sure the corporation diagnoses that they are creating a residual value bet either way. When the enterprise lease, they bet against the lessor but when the firm purchase, they bet against themselves. The corporation is bearing the risk that the truck’s worth will devalue more than anticipated, placing them on the owing position more on loan than the truck is worth. Leases will not cause the corporation problems since the lessor accepts the risk of sudden devaluation (Cressy, R. 1996).
2.5. Factor 5: The tax deductions the company get
Whether the corporation buys or lease, they are usually permitted to subtract the business costs of the automobile using either standard mileage rate for the tax year or their actual expenditures. The caveat is to take into account that the business cannot utilise the typical mileage rates but they must depend on certain expenses if the organisation buys or leases. In general, leases are typically more straightforward and faster to attain and have more flexible conditions than traditional term loans for purchasing assets. A corporation may be able to finalise lease of up to $100,000 in a few days and also to package several numbers of assets from a diverse range of suppliers into one lease, and, by performing so, they can acquire a lesser general charge. Also, modern accounting strategies permit for some asset leasing to be ‘off balance sheet,’ which implies they not displayed as debt or liabilities on the corporation’s balance sheet. Therefore, the asset procurements are not binding up the capacity of the enterprise’s debt.