Alpha Leasing Company
Leasing as a Hedging Strategy
Automobiles are a large investment for most people
"Purchase assets that increase in value and lease assets that decrease in value"

Part 1: Introduction

Part 2: Keep Vehicle: Value> Residual

Part 3: Keep Vehicle: Value = Residual

Part 4: Keep Vehicle: Value < Residual

Part 5: Sell Vehicle:  Value > Residual

Part 6: Sell Vehicle: Value = Residual

Part 7: Sell Vehicle: Value < Residual

Part 8: Conclusion
Part 1 of 8: Introduction

One interesting aspect of leasing is that it is in effect an insurance policy for automobiles.  The majority of the people in the United States trade-in or sell their automobile sometime before the end of its useful life.  This is especially true of business use vehicles, although the following analysis applies to any vehicle.  When calculating the total cost of ownership of a vehicle, the resale value is an important factor.  When you purchase a vehicle, while you can make an educated guess, you do not know  this value in advance.  However, with a closed-end lease, you know exactly what this value is.

With a purchase, you are taking resale risk.  With a lease, the lessor, not you, is taking the resale risk.  Let's look at a real world example.  In the fall of 2005 "Employee Pricing" became a popular promotion to combat soft new automobile sales.  On top of an already generous rebate program, these promotions combined to lower the effective selling prices of new vehicles by 3 to 4 thousand dollars. 

This drop in the price of new cars had a ripple effect into the used car market.  All indications are that, adjusted for inflation, used cars are selling for thousands less they were 4 or 5 years ago.  So how has this drop in used car prices affected people who purchased or leased a vehicle 4 or 5 years ago and are ready for a new vehicle.  People who purchased their vehicle are selling it for 2 to 5 thousand less than they ever imagined it would be worth.  They in effect are paying the price for the incentives offered by the auto dealers on new vehicles. 

In addition, as has been well documented, gasoline prices have risen sharply in 2005 and gas guzzlers, such as large SUVs, have fallen out of favor.  If you have a 4 year old Ford Expedition or Lincoln Navigator, or similar vehicle, you may find the value has gone down even more than $5,000.

But what about the people whose leases are coming due?  They just turn in the vehicle and keys to the leasing company and let them eat the loss.  The drop in the used car market doesn't cost them a penny.  So everything else being equal, those that leased were 2 to 5 thousand dollars ahead of those that purchased a vehicle and then sold it.  While we cannot guarantee that this situation will exist for everyone that leases a vehicle, the strategies in this section will show you how to come out even or ahead of people who purchase vehicles, in every conceivable situation.

To make our analysis simple, we will look at what a person will do with their vehicle at the end of four years.  While there are many other options available, most leases are 4-years, and many people that purchase vehicles trade in every four years.  Our analysis will ring true no matter what holding period we would have chosen.  At the end of the four years, you will either want to keep the vehicle or get rid of it.  The vehicle will be worth more than the residual, equal to the residual, or less than the residual.  So there are six possible scenarios.  In the pages that follow, we will compare the results for purchasing and leasing for each of these six scenarios.  For analysis purposes we will use a $30,000 MSRP vehicle that you can purchase or lease for $28,000.  The lease will have a residual of $15,000 at the end of four years.  We will look at a scenario where the actual value is $17,000 ( $2,000 more than the residual), $15,000 (equal to the residual), and $13,000 ($2,000 less than the residual).  To concentrate on the disposition issue, we have generated numbers where leasing and purchasing are almost equal from a financial standpoint.  Since the monthly lease payment is less than the monthly loan payment we assume that you invest your excess cash in a money market fund.  Check out our article for a details on investing excess cash.

Part 2:  Keep the Vehicle: Value is greater than the residual.

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