AMG, Inc. & Forsythe SolutionsLease Vs Buy Decisions

Problem Overview

Adam Stolz- financial manager of AMG- needed to determine if AMG should accept one of the leasing options(PCs) from Forsythe Solutions, or simply buy the PC’s 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

ASSUMPTIONSLease Evaluation

The lease starts at the beginning of the next month

Purchase evaluation

The PC’s 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

Forsythe’s 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 PC’s is taken into possession, and ends at a fixed time later

Coterminous Lease• A coterminous lease is defined as a lease

where all PC’s 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

• 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

Type of lease NPV

24 month coterminous$1,810,922.32

24 month rolling-$610,746.06

36 month coterminous$386,000.52

Buy-$6,139,950.98

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.