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Buy, lease, or rent? It all depends....

Buy, lease, or rent? It all depends

Want a simple answer to the dilemma of how to finance your new lift trucks this year? The bad news is there isn't one. The good news: here's an explanation of the factors you'll need to consider--in plain English.

Here's the situation: your company needs a fleet of 27 counterbalanced lift trucks for handling 6,000-lb loads of concrete roof tiles.

Your operators run the vehicles around the clock, 365 days a year. The trucks carry the tiles from an indoor manufacturing area to storage and loading areas located out of doors, and your company can't move product without them.

It's your responsibility to pick the best trucks for the application. What factors do you need to consider? Who do you need to consult?

Until recently, this kind of decision was handed over to the materials handling manager, and the final answer was based on factors that the manager could link directly to truck performance and productivity.

But now that same manager's decision-making process must include an alphabet of new factors--AMT, TMT, ITC, AMTI--that all together spell TAXES. What do taxes have to do with picking the right lift trucks?

Your company's specific tax situation, along with other financial considerations, can loom large in the decision: It is these factors that will determine whether you buy, lease, or rent the trucks, and perhaps even who the truck manufacturer or distributor will be. Increasingly, as we shall see, these factors favor leasing over buying for the majority of companies.

Mastering the ins and outs of corporate taxes and financing arrangements is a formidable task for the non-specialist. But having an overall understanding of these factors gives materials handling managers a competitive edge in their decision making.

A brief plunge into tax law

In the majority of cases, the decision whether to buy or lease an industrial truck is largely a function of the tax laws. Because the tax laws can change at any given moment that Congress is in session, the relative advantages of buying versus leasing industrial trucks can also change. (The term renting as it applies to trucks is basically one form of operating lease and will be included in that category.)

In general, though, tax experts interviewed for this article say that our current tax laws favor leasing, primarily because of the effects of the Tax Reform Act of 1986.

The Tax Reform Act of 1986 eliminated the traditional investment tax credit (ITC) for purchases of new equipment, which means that owning assets now carries a higher capital cost.

At first, many industry observers thought the Act would have a negative effect on leasing: the elimination of the ITC would reduce the depreciation benefits for the lessor, and therefore reduce the benefits passed along to the lessee in the form of lower lease rates.

However, the Act also imposed a new tax--the alternative minimum tax (AMT)--on companies, and the AMT has largely offset the negative effect that the elimination of the ITC had on leasing. While the AMT does not apply to all companies, it does affect the majority of those that use significant amounts of materials handling equipment. The tax advantages of leasing are generally greater for companies that are subject to the AMT than for those that are not.

The AMT makes it more difficult for corporations to use certain standard tax deductions to reduce their tax liability. The AMT changes these tax benefits into "tax preference items" which are in turn added back to a company's regular taxable income. Or as the leasing consulting firm of Amembal Isom explains it, "The AMT is, in essence, the taxing of a deduction, although it is taxed at a different rate."

The tax preference items become the company's alternative minimum taxable income (AMTI) which is taxed at the rate of 20% to arrive at the tentative minimum tax (TMT). The company's tax liability will be the greater of two calculated amounts, either the regular income tax or the TMT.

If tax preference items are exactly equal to 70% of the company's regular taxable income, the company will not be in the AMT category (assuming the standard federal corporate tax rate of 34% on taxable income). But if tax preference items exceed 70%, the company will find itself subject to the AMT.

In a nutshell, the end effect of these tax laws is that your company's tax accountants probably want to keep your company from being subject to the AMT. Because lease payments are not considered as tax preference items, leasing may well benefit your company.

On the other hand, when a company purchases equipment and uses the straight line depreciation method for regular tax purposes, a depreciation preference is not created. However, after-tax benefits may be lower with straight line depreciation.

And in addition, the after-tax discount rate will be lower for a company that does not fall within the AMT category than for one that does.

When should you lease?

According to Ted Werner, general manager of direct sales at Hyster Company, approximately 85% of all materials handling equipment is now acquired through some form of leasing agreement. He maintains that "improved productivity and increased profitability result from the use of better lift trucks and accessories, not the ownership."

Clearly, the nationwide trend is toward leasing industrial trucks, rather than purchasing them. Industry experts estimate that at least 60% of all industrial trucks acquired by U.S. firms last year were leased. When is leasing the right answer?

* When tax or financial considerations such as AMT liability favor leasing;

* When your company wants to conserve capital, keep lines of credit open, and reduce cash outlays;

* When upgrading or regular replacement of trucks is anticipated; or

* When the company needs the stability that leasing can lend to forecasting operational costs.

There are two basic types of leases available to lift truck users--operating and capital. Both types have several different forms and variations.

Generally speaking, operating leases are used by companies that do not want to purchase the trucks at the end of the leasing period; capital leases are favored by companies that want to end up owning the vehicles.

Chris DiLucia, sales manager at Clark Rental Systems, explains that there are also some specific technical differences between the two types. For example, to qualify as an operating lease:

* The lease must not transfer ownership to the lessee at the end of the lease term;

* The lease must not contain a bargain purchase option;

* The lease term cannot be equal to 75% or more of the estimated economic life of the leased truck; and

* The present value of the minimum lease payments (excluding executory costs), including guaranteed residual value, cannot exceed 90% of the selling price (fair value) of the trucks as required by the Financial Accounting Standards Board (FASB).

According to Gloria Norton, manager of lease marketing/sales at Raymond Leasing Corp., with an operating lease there is no requirement to add the asset and related liability to the balance sheet (although the amount of lease obligations must be footnoted on financial statements). The monthly lease payment is charged directly to the income statement as an expense. An operating lease is therefore easier to account for.

In most cases, a rental contract is actually a form of operating lease. Rentals are usually arranged for short periods (such as for a few months of peak season demand), and frequently don't include any obligation for the lessee to perform maintenance.

A capital lease, explains Yale's Jeff Enoch (manager of Yale Financial Services) is listed on a company's balance sheet as an asset that can be amortized over the length of the term of the lease. The monthly expense of the capital lease (also called a finance lease) constitutes a liability that is equal to the present value of the minimum lease payments.

With either type of lease, maintenance costs may be the responsibility of the lessor or the lessee or both, depending on how the lease is structured.

When should you buy?

The outright purchase of an industrial truck makes sense for some companies. The justification may be related to intended use or it may be financial.

When should you buy rather than lease?

* When outright ownership of lift trucks (i.e., of capital assets) is preferred;

* When the company's tax or overall financial situation favors purchase;

* When you require highly specialized trucks;

* When materials handling requirements are projected to remain stable;

* When the operating conditions and environment are favorable; or

* When long-term use of the vehicles is predicted and preferred.

For example, if a truck will be operated under relatively easy conditions and if materials handling requirements are projected to remain fairly constant, a company may plan to use a truck for ten years or more. Under these circumstances, outright ownership may be preferred.

If the company realizes tax advantages from using straight line depreciation purchasing may be the best choice.

In addition, ownership may give a company the flexibility it needs to dispose of parts of its truck fleet as business conditions change; a lease may not permit early termination.

A company may pick outright purchase over some form of leasing arrangement for emotional reasons as well: leasing capital equipment is still a new concept for some companies, especially smaller concerns.

Keep in mind that it makes little sense to choose outright purchase if your fleet maintenance program is not top-notch. Lift trucks that aren't properly maintained will inflate your operating costs and decrease the resale value of your assets. Even with good maintenance, though, once lift trucks pass their optimum economic life, the odds are they will absorb a steadily increasing percentage of your fleet maintenance budget.

One company's decision

The example we used at the beginning of our article concerns a real manufacturer--Lifetile Company of Rialto, Calif. Lifetile is the largest manufacturer of concrete roof tiles in the U.S.

Michael Chung, company controller, is the man who was faced with the decision of which lift trucks to acquire and how to finance them. Chung explains: "By any standard, ours is an extremely tough environment for a lift truck, but despite that, we can't afford unscheduled downtime. We needed to pick the most durable, reliable, productive trucks we could find. But in addition, we had to add in a whole lot of financial factors before we could make a decision."

His choice was a fleet of 9,000-lb-capacity, LP-gas-powered counter-balanced trucks equipped with pneumatic tires and custom forks. By specifying trucks capable of handling 50% more than the typical load, Chung anticipates reliable, consistent performance and limited maintenance-related downtime.

According to Michael Chung, the second decision--the type of financing to choose--was dictated by the harsh working conditions for the trucks. Given the 24-hour-per-day operating requirement, the heavy loads, and the dusty environment, he predicts that after about two and a half years, the truck fleet will be nearing the end of its useful service life.

The company considered both outright purchase and several forms of leasing. Purchasing posed certain tax disadvantages for the company, along with two other problems. Lifetile did not want to continue to use the trucks after the vehicles reached the two-and-a-half-year mark; nor did the company want to be faced with disposing of the used trucks at that time.

The company therefore settled on an operating lease that allows Lifetile to pay a flat fee on a monthly basis for the use of the trucks. At the end of the leasing period, the company will return all 27 trucks to the distributor, and then lease another fleet of new vehicles. Disposal of the used trucks will be the responsibility of the distributor or the lift truck manufacturer.

Michael Chung's decision, then, was based on:

* The make and model of lift trucks that he thinks will be the most productive and reliable for his particular application;

* The nature of the operating environment and conditions under which the trucks will operate, and the effect these factors will have on the service lives and resale value of the trucks;

* The current and anticipated tax situation of his company;

* The type of financing package the company wanted; and

* The availability of this financing package through the local lift truck distributor or a leasing company.

Today, more than ever before, it's these last three factors that materials handling managers must consider.

But don't forget performance

While leasing is used more frequently now than outright purchase, both approaches offer advantages in specific situations. For materials handling managers, an important point to remember is that the buy versus lease decision must be made within the context of the company's current and anticipated tax and financial situations.

But a second important point to bear in mind is that a company that decides which lift trucks to acquire primarily on the basis of tax and other financial factors may end up with the wrong trucks. Says Dick Falkner, Crown's financial merchandising manager: "If the main consideration for specifying lift trucks is purely financial, rather than both operational and financial, then it's easy to pick the wrong equipment. The bottom line for a company should be to choose the lift trucks that do the most efficient job for the least overall cost (and that includes their purchase cost, operating cost, maintenance cost, and resale value)."

Or as Jim Yule, merchandising consultant at Caterpillar Financial, puts it: "Today, a materials handling manager has got to be able to integrate more different factors than ever before when making this kind of decision. The decisionmaking process is far more complex than it used to be, but managers have to learn to live with it--a company's competitiveness depends on it."

PHOTO : A top-notch maintenance program is absolutely essential for companies that choose to own

PHOTO : their lift trucks. Increased downtime and operating costs, and decreased resale value are

PHOTO : the alternatives.
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Title Annotation:Industrial Truck Report; includes related article on leases
Author:Gould, Les
Publication:Modern Materials Handling
Date:Mar 1, 1990
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