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What is the advantage of computing the present value of outflows in making lease versus buy decision?


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Answered 2007-12-06 19:54:40

The advantage is that you take into account the time value of money. That sounds complex and is somewhat complex. What is the time value of money? There are advantages to getting a dollar today versus getting a dollar at a later date. If you have a dollar today you could invest it and earn money with it. If you get you dollar later you cannot invest in thus you cannot earn money with it. And there is inflation which means that you can buy more with your dollar today than at a later time. I guess an example is needed. Pete receives $100 today and places it in savings account giving him 5% interest. One year from now Pete has $105. The $100 get got today and the interest the bank paid him. John will receive his $100 in one year. He cannot invest it for a year. Thus one year from now he still has $100. So it is better to get the $100 today instead of one year from now. Inflation has a similar but opposite effect. Let's say you that today you can buy 100 apples with $100. One year from now the price of the apples has increased and you can only buy 90 apples with $100. So you can say that your dollar has become less valuable because you can buy fewer apples with the same amount of money. By calculating the present value of the outflows you calculate what the value is of the dollars you spend during the time of the lease. And you express that in today's dollars by taking into account the inflation during the time of the lease. Making this calculation is not that easy. Not only do you have to calculate the outflows but you also have to take into account the value of the car at the time the lease expires. But if you make the calculation you get a much more accurate picture of which option, buy or lease, represents the better deal for you.

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