Question

Explain the five steps of the capital budgeting process,why organizations choose to lease equipment over purchasing it?

Answer 1

1. Identifying opportunities: Research, R&D and surveys are done to identify opportunities for investment. This helps in determining initial investment, selection of equipment, and timing of initial investment to get maximum value out of it.
2. Estimating the revenue and cash flow: The capital budgeting helps to identify the increase in revenue due to accepting of a project. In some cases like replacing a machine might not result in increase revenues but may result in cost savings. This is identified in this process. Apart from it helps too identify the cash flows due to depreciation tax shield, after tax salvage value, etc.
3. Estimation of Costs: The costs associated with the project like operating expense, maintenance costs, opportunity costs are calculated in this process. This represents the cash outflow.
4. The risk identification: The risk is calculated in terms of WACC. This is used to estimate the net cash flow. Hager the risk higher is the WACC and higher the discounting.
5. Final decision and implementation: Base on NPV or IRR calculation the final decision might be taken and implementation of the project might be done.

1. Identifying opportunities: Research, R&D and surveys are done to identify opportunities for investment. This helps in determining initial investment, selection of equipment, and timing of initial investment to get maximum value out of it.
2. Estimating the revenue and cash flow: The capital budgeting helps to identify the increase in revenue due to accepting of a project. In some cases like replacing a machine might not result in increase revenues but may result in cost savings. This is identified in this process. Apart from it helps too identify the cash flows due to depreciation tax shield, after tax salvage value, etc.
3. Estimation of Costs: The costs associated with the project like operating expense, maintenance costs, opportunity costs are calculated in this process. This represents the cash outflow.
4. The risk identification: The risk is calculated in terms of WACC. This is used to estimate the net cash flow. Hager the risk higher is the WACC and higher the discounting.
5. Final decision and implementation: Base on NPV or IRR calculation the final decision might be taken and implementation of the project might be done.

Organisations choose to lease equipment over purchasing
1. It lowers the initial investment of a project. Leasing does not involve buying a new machine.
2. Lease expense can be used as tax deducting tool.
3. Problem of replacing old equipment or machines is not there. As at the end of the term o0f lease new equipment can be leased again and hence easier to upgrage with minimum costs.
4Flexible Terms: Leasing has flexible term than taking loans to buy, machine and then using it. The credit terms can be negotiated to the benefit of the lessee.