Question

a)Imagine that you are the Chief Financial Officer (CFO) of a startup airline company. The executive management team has tasked you with making a recommendation about whether the company should buy or lease airplanes. Analyze the major pros and cons for leasing and buying assets. Based on your analysis, provide a recommendation to the executive team.

b)Compare and contrast the three (3) methods for depreciating plant assets. Recommend the method that maximizes profits for both a shorter period of time and a longer period of time

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Answer 1

Pros of buying asset;

Followings are the major pros of buying asset;

1. Buying of asset provides right of ownership.

2. Buying provides flexibility in the use of assets or we can say that buyer of the asset can make required changes as per need.

3. Right of resale is available in case of buy of a asset which is not available in case of lease.

4. You have option to make payment one time which is normally not available in case of lease because under leasing of the asset regular payment needs to be made.

Cons of buying asset;

Followings are the major cons of buying asset;

1. Buying of asset needs heavy down payment which is major negative point.

2. High monthly financial costs. Apart from high interest burden on financed money.

3. Heavy loss due to depreciation of the asset.

4. Heavy outflow of cash from the firm.

5. Regular technological changes affect significance of bought assets.

Pros of leasing asset;

Followings are the major pros of leasing asset;

1. Low down payment at the time of leasing asset.

2. Low monthly payment.

3. No fear of technological change because we receive new updated asset after some time.

4. It does not affect cash flow of the firm heavily.

Cons of leasing asset;

Followings are the major cons of leasing asset;

1. Right of ownership is not available under leasing asset.

2. There are some limitations for use of leased asset.

3. Required modifications can not be made in this case.

4. Profits of resale of the asset is not avialable in this case.

So, on the basis of above explanation, it is clear that airline company should lease airplanes because we know that buy airplanes needs huge finance but in case of of leasing such negative effects will not be on airline company. Apart from this and change in the technology will not affect airline company if airplanes are leased. All other associated risks also can be avoided in case of leasing. Thus leasing is the better option for this company.

(b).

Followings are the three methods of depreciating a plant assets;

1. Straight line method;

This method of depreciation is commonly used by the firm for depreciating plant assets because it is very simple in use. Apart from this an equal amount of depreciation is charged during the life of asset. In case of other methods like double declining balance method amount of depreciation expense differs year by year. But this method provodes similar amount of depreciation each year.

2. Double declining balance method;

Under this method amount of depreciation is charged on reducing balance each year thus in initial years high amount of depreciation expense is charged but in the later years low amount of depreciation expense are charged. We can say that this method is much complicated in use that is why firms do not accept this method easily because in the initial years it will reduce profitability of the firm but in later years it will increase burden of tax expenses on the firm.

3. Units of production method;

Under this method, depreciation expesne is calculated on the basis of actual production level in the year. So this method looks more technical & scientific because depreciation expense is charged on the basis of actual level of production each year thus as a result it will result into resonable amount of depreciation expense and it neither negatively affect profitability of the firm not it result into lower or higher tax burden.

So, on the basis of above explanation we can say that a firm should adopt units of production method of the depreciation because it will help in calculating real amount of depreciation expense in all years and it will not result into inadequate tax complication. As we know tha in case of straight line method, depreciation is remain same whether use of assets is higher or lower whereas in case of double declining balance method high amount of depreciation is charged in initial years inspite of lower use of assets thus both methods looks inappropiate. So overall we cans say that units od production method is suitable for a firm.