The Decision Process Behind Acquiring An Asset Finance Essay - Free Essay Example

Sample details Pages: 5 Words: 1404 Downloads: 3 Date added: 2017/06/26 Category Finance Essay Type Analytical essay Did you like this example? To make a decision about how to acquire an asset is not an easy task. There are many aspects to take into account which can, and will, influence this process, such as: strategic vision, availability of the asset, shareholders interest, etc: but this type of decision always is going to be affected by the financial. For the aim of this analysis, is assumed that the company has the liquidity enough to buy the asset and the aspects referred to other than cost effective analysis are not important for the decision, and that the financial options to acquire the asset are basically purchase the property, borrow found or leasing. Decision process The decision process can be split in two main parts: the investment decision and the financial decision. The former is the analysis if the company needs to use the asset and which is the way to acquire this equipment, even hire or have a economic ownership over it; if the company could not find viable to hire the asset for a short term, is when the second one came to the decision process, the financial decision is an analysis of the way that the companies are able to acquire the equipment, we can usually find: Retained Earnings Increase Capital Long term debits Short term loan Hire-Purchase Leasing Purchase In the real market, the most expensive founds are shareholders resources, they expect that the company give them profits above the market profitability and that the company increase its value, that is the reason why a financial manager have to design the best option with the aim of minimize the use of their money, that is the easy way, but not necessarily is the most cost effective one- Leasing Lease, as a financial tool, has its beginnings in the mid 19th century when Helby v. Matthews managed to recovered property could be leased to a third party. But only in the early 19s when it was legally and financially acceptable to the market, but was only in 1960 when its use was crowded in the world thanks to the benefits it provided to small and medium enterprises. (Bierman, 1982) Definition: [ A lease is a contract between a lessor and lessee for the hire of a specific asset selected from a manufacturer or vendor of such assets by the lessee. The lessor retains ownership of the asset. The lessee has possession and use of the asset on payment of specific rentals over period. (Equipment Leasing Association, 1976, pp 1-2) Types of Leasing Financial leasing: IAS defined it as the lessor transfers to the lessee substantially all the risk and rewards incident to ownership of an asset. Title may eventually be transferred in this kind of leasing the lessor is able to recover the capital cost of the asset, maintenance and a return of the investment. Operative Leasing: any other leasing different to financial leasing. (Clark,1985) Advantages of Leasing To the lessee: Leasing provides up to 100% of the cost of the equipment Leasing do not affect the debtÂÂ ´s capacity A leasing provides a better cash flow in the actual year to invest in other uses A lease is not cancellable, which means that the parties have certain of their payments It is a good shield against changes in macro economical factors such as inflation As the asset is not property of the lessee, this one do not have to worry about accounting and administrative procedures such as depreciation, tax, etc Leasing is tax deductible because it is part of the operational costs To the lessor: Reduction of risk in case of a lessee default, because is easy to repossess the asset Financial practice when the owner of the assets not only has the property of the equipment plus profits due to the use of his assets Save time. Leasing is a financial model which can be decided, executed in short time. Disadvantages To the lessee: Property of the assets and loss the residual value at the end of the contract To the lessor: A ffect the debtÂÂ ´s capacity Maintenance risk Non-pay or bankruptcy (Clark, 1978) Time Value of Money If we want to compare between different real options of investments, the value of the money in the time is the only way to do it; every project have a period where it is going to take place, and we can not assume that the value of the cash flows in the beginning of this have the same value that the ones that we are going to receive in future periods. Is in that moment when the discounted cash flows methods help us to bring all this futures incomes or/and outcomes to a point in the time when we are going to analyze them. (Gotze, 2008) One of the most accepted discounted cash flows methods is the Net Present Value (NPV), Gotze, Northcott and Schuster, in their book Investment Appraisal pp 54 defined it as the net monetary gain (or loss) from a project computed by discounted all present and futures cash flows related to the project, T M Clark, in his book Leasin g, pp 194, says it is the method of discount futures cash flows back to the start date of a project using a determinate discount rate. At the end of the day, this methods are simple to discount the futures cash flows using a discount rate to the year cero to compare in real values and to be able to make a accurate decision, in mathematical worlds we can say that NPV is: Where: t = time index T = The year of the last cash flow CIF = Income in the year t COF = Outcome in the year t I = discount rate (Gotze, 2008) ANALYSIS In this analysis we are going to use a company which expansionÂÂ ´s plan includes acquire a property; and the options includes: to buy with 100% equity, to borrow 70% of banks or leasing. The chart and the figures are shown in the table above together with the PV of the futures cash flows and the VPN calculation Actual Situation: Chart: Present Value Calculations of each of the futures cash flow NPV calculated by addition o f present values: NPV calculated by addition of present values and NPV concept: And figures calculated with annualities In the first part of the analysis, is used the present values of the future cash flows and discounted by a cost of capital of 10% to the beginning of the year cero and then summarized in order to calculate the NPV of the project: for the first option the value is -$5.374.528, for the second option is -$3.768.067.54, and the last one is -$3.573.508.51. As we can see, this project under this cost of capital is not viable in any of the tree options, but if we have to choose one, because the project is relevant to the company strategical goals and because they are mutually exclusive we should choose the less negative NPV. In the second part of the figure, I calculated the NPV of the future cash flows to the end of the year 1 and compare the values in this time, and the answer is the same that the previous point, which means that the best option for the comp any, is to acquire a lease instead of purchase the property. For the second figures, I used a figure called annuality in two of three options, which is present when the future cash flows are the same value but in different stages of the project, the result, as it has to be, is the same that we concluded in the previous analysis. As we can see in the figures, it does not matter if you calculate the net present value (NPV) using the formula or the sum of the Present Values, even annualities show that the best option is leasing, but we have to understand that this kind of model decision is not influenced by the strategical objectives of the company: for example, what if the company is interested in increase its fixed assets in the balance sheets? In this case the best option could be the second one, or if the company in the previous case but moreover does not like get loans with financial institutes? Then the best option should be the purchase with 100% equity, but like in this c ase, as we do not have any kind of limitation, the less NPV determines the best option, and became in a good strategy for the company. Don’t waste time! Our writers will create an original "The Decision Process Behind Acquiring An Asset Finance Essay" essay for you Create order