AMG, Inc.

& Forsythe Solutions

Lease Vs Buy Decisions

Problem Overview
Adam Stolz- financial manager of AMGneeded to determine if AMG should accept one of the leasing options(PCs) from Forsythe Solutions, or simply buy the PCs from the Forsythe Solutions.

AMG Profile
It was a fortune 500 company It has six business units: credit cards, personal loans, home loans, insurance, savings, and brokerage AMG operates in over 20 locations The Weighted Average Cost of Capital (WACC) for AMG is 15% Tax rate is 34% Adam Stolz handles projects worth more than 1 Million

Forsythe -Introduction
Rick Forsythe and partner Jim McArthur started a company in 1970 It enjoyed the first of 30 consecutive profitable years It has about 2,500 Information Technology (IT) customers and nearly 600 employees It is the major vendor for AMG

Roll out schedule

IT Dept needed to roll out 7542 new PCs It occurs over 12 months to multiple locations Each PC costs $1000 $750 for hardware and $250 for software ASSUMPTIONS
Lease Evaluation The lease starts at the beginning of the next month Purchase evaluation The PCs are purchased at the beginning of each month

Roll out Schedule

Depreciation and salvage value

Hardware
AMG Inc. uses MACRS depreciation schedules for all PCs over % years

Salvage Value of one PC is $50

Software
No depreciation exists on software Zero salvage Value

Forsythes lease quotes

The lease options consist of a 24-month lease and a 36-month Each lease has two payment schedules They are monthly takedowns/billed monthly and quarterly takedowns/billed monthly Each lease can either be a rolling leaseline or a coterminous

Rolling Lease A rolling lease is defined as a lease that starts from the time each PC or group of PCs is taken into possession, and ends at a fixed time later Coterminous Lease A coterminous lease is defined as a lease where all PCs will end on the same date.

Lease Terms Equity insertion is10.1% in a 24-month deal Zero equity in a 36-month deal Current Cost of Capital for AMG 36-month hardware: 8% 36-month software: 12% 24-month hardware: 7% 24-month software: 11%

Methodology
Incremental analysis was done for calculating the NPV of marginal benefits in the following cases: 24 month coterminous lease 24 month rolling lease 36 month coterminous lease Buy for a period of 24-month and sell scrap The cost of PCs is taken as incremental cash inflow in lease case and outflow in buy case Tax savings on depreciation of hardware is taken as inflow in buy case and outflow in lease case

Lease v/s Buy Decision

Type of lease 24 month coterminous $1,810,922.32 24 month rolling -$610,746.06 36 month coterminous $386,000.52 Buy -$6,139,950.98
Based on the above table, it can be recommended that 24 coterminous lease gives the maximum savings to the company in form of lesser capital investment Hence AMG should go for a 24-month coterminous lease provided by Forsythe solutions

NPV

Assumptions
We have assumed that the lease payments are made 1 month in advance. For a lease starting in April payment is made in March The rate for discounting the monthly cash outflows is 1/12th the annual rate Depreciation for the year is accounted for in December month. The depreciation is calculated on average inventory over the year Software is not capitalized and hence not amortized. Depreciable base for hardware = $600 per PC We assume that PC is sold after 24 months at scrap value hence no taxes 36-month rolling is not considered as it would give negative NPV

Thank You.