Question

When acquiring an asset, what are the advantages of renting vs. buying/owning the asset? If a company decides to buy an asset, what are the advantages and disadvantages of paying cash versus financing with debt?

Answer 1

Advantages of acquisition of assets in form of Rent over purchase always follows:

• Usually repairs and maintenance expenses are borne by the owner. Hence these unplanned expenses can be ignored while budgeting, making budgets simpler.
• Initial security deposits are cheaper than down payments. Hence upfront payments will be lesser.
• Rent payments cost lesser than monthly debt payments.
• Flexibility in choosing and switching from asset as per need and requirements is easier in rent than purchase.
• No extra burden of disposal of assets as they're not owned.

2.

1. Advantages of financing with own cash:
   1. There is no payment risk as there is no obligation to pay EMIs and Interests.
   2. Useful for the ogransiation who have lower credit scores and raising debt will be genuine difficulty.
   3. Debt funding drives cash flows out of business in form of interest and EMIs.
2. Disadvantages of funding by own cash:
   1. As cash resource are invested into asset they may be usually costlier than debt financing as opportunity cost are higher than debt.
   2. Owner may invest all cash into assets and hence face porblems of poor liquidity.
3. Advantages of debt:
   1. Interest are tax deductible. Hence some portion that would be paid in a way of taxes will be reduced.
   2. Cash Resources saved by funding through debt can be invested elsewhere and hence generate additional income.
   3. Since interest, instalment and EMI payments are known and uniform, budgeting becomes easier.
4. Disadvantages of debt:
   1. There will demand for collateral securities on assets from creditors making business lose its control over the asset.
   2. There will be obligation to make payments periodically regardless of organisation's cash health and financial performance.
   3. Problems of Cash crunch, insolvency and illiquidity creeps in if debts are poorly managed.