LO 3.3.4: Determine key considerations involved in the decision to purchase or lease an asset.

Question 1

How does a financial planner help a client asking about buying an asset versus leasing it

Answer 1

by educating them about advantages and disadvantages of each.

Question 2

Leasing an Asset | Parties to a lease

Answer 2

• Lessor: the person or business that owns the asset and leases it to another.
• Lessee: (borrower) the person who leases, or rents the asset.

Question 3

Leasing an Asset | Lease payment

Answer 3

Based on amortized cost of the initial price of the asset - the residual value expected at the end of the lease

• Example on p. 117:
  
  • Client leases $26,000 car for 4 years.
  • After 4 years, expected residual value of the car will be $16,000 (the car’s value @ end of lease)
  • Lease payment is based on $10,000 net value + interest (value of the car during lease period)

Question 4

Types of Leases | Closed-end lease

Answer 4

• AKA. fixed-cost lease
• Lessee agrees to pay a stated monthly fee for the use of the asset for a specified time period
• In long-term leases, payment may be automatically adjusted for inflation during life of the loan
• At end of lease period, lessee can turn over the equipment and lease new equipment.
• Normal wear and tear is included, but there are provisions for unusual/exceptional use or damage; may create additional financial obligation for the lessee.
• TF, although there are no additional end-of-lease costs, excessive wear and tear or property damage may require additional cost
• This type of lease is used by businesses to acquire equipment, e.g. electronics.
• Also an option for consumers interested in leasing an automobile.

Question 5

Types of Leases | Open-end lease

Answer 5

• AKA. finance lease or equity lease
• Payments calculated by difference in purchase price and what it is worth at the end of the lease
• If you go above a certain number of miles, you have to pay an additional amount.
• Generally lower monthly payment than a closed-end lease bc the lessor is protected for excessive wear and tear (not protected on a closed-end lease).
• • At the end of lease, lessee (borrower) may owe lessor additional money if the asset rents or sell for an amt that is less than the value projected at the time the lease was initiated
• Another option for consumers interested in leasing a vehicle.

Question 6

Decision to buy or lease rule of thumb

Answer 6

Generally, if an item has a limited useful life for clients, may be wise for them to lease it.

Question 7

Buying or leasing a home

Answer 7

The economics depend on the following factors:

• 1). Price of existing homes
• 2). Mortgage interest rates
• 3). Length of time in home
• 4). Expectation of home price increases
• 5). Perceived income tax benefits (higher marginal tax bracket, greater advantage of home ownership)

Question 8

What are the tax benefits of home ownership

Answer 8

• Itemized deductions for property taxes and home mortgage rates
• Higher the client’s marginal income tax bracket, the greater advantage of owning a home.

Question 9

What are the costs involved with leasing a home

Answer 9

• 1). periodic rent obligation,
• 2). renter’s insurance policy,
• 3). cost of utilities,
• 4). security deposit may also be required depending on credit history.

Question 10

What are the costs involved with owning a home

Answer 10

• 1). Mortgage payments,
• 2). Real estate property taxes,
• 3). Homeowners or condo association fees (HOA),
• 4). Homeowners insurance premiums,
• 5). Maintenance expenses,
• 6). Utility bills,
• 7). Potential ROI forgone on funds used for down payment and closing costs (opportunity cost)

Question 11

Prefer home buying

Answer 11

• Intends to live in an area for many years
• Can benefit from the income tax advantages of ownership
• Wants to improve appearance of structure of the residence

Question 12

Prefer home leasing

Answer 12

• Does not have the funds for a down pmt
• Has a temporary housing need (moving for job)
• Expects housing needs to change and does not now own
• Looking for a job or changing careers, which could require a move within a few years.

Question 13

Purchase or lease an automobile

Answer 13

• Same cost-benefit analysis applies as buying or leasing a home
• Auto lease principal and interest is not tax deductible to individuals
  
  • may qualify as a tax deduction for business purposes.

Question 14

What is the decision to purchase or lease an automobile based upon

Answer 14

• Time value of money analysis:
• • greater up front cost of purchasing the car vs.
• • leasing and investing any money saved
• At times leasing a car is more expensive than buying it for cash or taking out a loan

Question 15

Prefer auto buying

Answer 15

• Keeps an auto for many years
• Drives well over 15,000 miles per year
• Wants to discontinue payments eventually

Question 16

Prefer auto leasing

Answer 16

• Wants to have a new auto every 2-4 years
• Does not have funds for 20% or more down payment
• Will not drive the auto more than 12-15K miles per year
• Uses the auto for business
• Needs a lower monthly auto payment and is willing to give up ownership for the lower payment