Monday, October 5, 2009

Disadvantages of leasing

The commonly cited disadvantages of leasing include high interest costs, the lack of salvage value, the difficulty of making property improvements, and obsolesce considerations. Though not relevant in every case, they may bear importantly on the
lease-purchase decision in certain instances.
High interest cost. A lease does not have an explicit interest cost; rather, the lessor builds a return for itself into the lease payment. In many leases the implicit return to the lessor is quite high, so that the firm might be better off borrowing to purchase the asset.
Lack of salvage value. At the end of the term of lease agreement, the salvage value of assets, if any, is realized by the lessor. If assets are expected to appreciate over the life of a lease agreement, it may be wiser to purchase them, although various other factors must be considered in making this decision. Appreciation in the value of assets is especially likely when land or buildings, or both, are involved. If the lease contains a purchase option this disadvantage may not exist.
Difficulty of property improvements Under a lease, the lessee is generally prohibited from making improvements on the leased property without the approval of the lessor. If the property were owned, this difficulty would not arise. Related to this disadvantage is the fact that it is often hard to obtain financing for improvements on leased property since it is difficult for the lender to obtain a security interest in the improvements. On the other hand, the lessor may agree in the initial lease contract finance or make certain leasehold improvements specified by the lessee.
Obsolescence considerations. If a lessee leases (under financial lease) an asset that subsequently becomes obsolete, it still as to make lease payments over the remaining life of the lease. This is true even if it is unable to use the leased asset. In many instances, a lessee will continue to use obsolete assets since it must pay for them. This type of situation can weaken a firm's competitive position by raising (or failing to lower) production costs and therefore forcing the sale price of its products to be increased in order to earn a profit.

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