Leasing Decision at Magnet Beauty Products Inc

Leasing Decision at Magnet Beauty Products, Inc.

1. Magnet Beauty leases all of its stores from the same lessor. They have determined that leasing makes more sense than buying properties. Describe the process that most companies undertake to make lease-versus-buy decisions.

In my opinion, I will use NPV Analysis to make the decision which I will prefer leasing or purchasing. However, before I start to calculate the NPV, I will simplify the cash flow in the first step. I need to subtract the direct cash flows of buying from leasing and get the cash flows from leasing relative to the cash flows from the purchase. Since we have the net cash flow, we can analysis the NPV and calculate it if the net present value of the incremental cash flows from leasing relative to purchasing is positive or negative. If the answer is positive, I will prefer leasing, otherwise I will choose purchase.

2. Once a company decides to lease, there are a number of different ways a lease may be classified for accounting purposes. Identify and describe the different classifications, including (1) how to determine the right classification, and (2) the different ways they would be presented in the company's financial statements.

There are two classifications which one of them is operating lease and the other one is capital lease. We can distinguish them by the following aspects, if the lease meets these conditions, we can conclude it is a capital lease, otherwise, it is a operating lease.

a. The present value of the lease payments is at least 90 percent of the fair market value of the asset at the start of the lease.

b. The lease transfers ownership of the property to the lessee by the end of the term of the lease.

c. The lease term is 75 percent or more of the estimated economic life of the asset.

d. The lessee can buy the asset at a bargain price at expiry.

(2) the different ways they would be presented in the company's financial statements.

Lease liability: Lease liability is always hidden with an operating lease which is shown on a capital lease that means the operating lease do not appear on the balance sheet while the capital leases appear on the balance sheet.

3. Using the information in the exhibits, compare the impact of Magnet Beauty's two lease options on their income statement, balance sheet, and cash flow statements.

Income statement: The five-1 lease had more total operating expenses than the 3 plus 2 year lease while they had the same profit. On the other hand, the EBITDA in 3 plus 2 year lease decreased in year 1 and increased through year 2 to 5, the EBITDA in five-1 year leases increased all the time. As a result, although the net income of 3 plus