The economics of buy vs. lease

According to a news report, a Comelec commissioner gave a statement on the purchase price of PCOS machines:

Larrazabal said with the reduced number of PCOS to be purchased they also expect the cost to drop to P22 million from P52 million original cost estimate. “There’s a big discrepancy. It is cheaper to purchase the machines than lease it,” he said.

Questions:  Why is it cheaper to buy than to lease?  If that is a “discrepancy,” who has the responsibility to deal with such a discrepancy?

Hint for answers:  Comelec is an independent constitutional body.

Some simple arithmetic:  It seems that the purchase price of a PCOS machine is now of the order of US$400.  The lease price, on the other hand, is roughly $2,000.  (If the purchase price is reasonable, the lease price cannot be.  More likely, the purchase price reflects the “stale goods” nature of the machines, a bit like selling a two-week old newspaper.  Its true opportunity cost to the seller is zero because it would have been written off anyway, so the price is in a sense “pure profit.”  Is that reasonable?)

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10 thoughts on “The economics of buy vs. lease

  1. The problem with your analysis is you based it on WRONG assumptions and therefore your “simple arithmetic” is also obviously WRONG. The purchase price as indicated is calculated based on the terms of the contract which is basically a lease with option to buy until December 31, 2010. Please make the necessary erratum if you are truly a fair blogger/journalist lest you be tagged as biased.

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    1. I don’t understand your comment. Maybe someone else out there can explain. Or you can be more humble and not demand errata if you can readily explain my “error.” So so sorry that I offend your sense of “fair bloggery.” Perhaps Commissioner Larrazabal should also issue his own “erratum” or explanation. There, there.

      I’m quite happy to be tagged as biased – in favor of transparency.

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  2. OK, let me humbly explain by first quoting your question: “Why is it cheaper to buy than to lease? If that is a “discrepancy,” who has the responsibility to deal with such a discrepancy?”

    First of all, the contract is a lease with option to buy. Using your numbers (which is probably not accurate but for the sake of an example), the cost of lease is roughly $2,000 and if Comelec exercises the option to buy on or before Dec. 31, 2010, it will cost them an additional $400 to take asset ownership. There is no discrepancy as you claim and the purchase price is not $400 and cheaper than the lease price. The actual purchase price is $2,400.

    Another wrong assumption you make is “its true opportunity cost to the seller is zero because it would have been written off anyway, so the price is in a sense “pure profit.” Not true at all because Comelec only opted to buy around 1,000 units of the 76,000 units. What will happen to the 75,000 units that Comelec didn’t buy? It reverts back to Smartmatic who will have to shoulder out the costs of storing them in a warehouse somewhere. How could that be pure profit based on your “in depth” analysis.

    And to think that you are an ex-World Bank economist, whoopsee! Hope this is not one of the lessons you teach your students in Siliman.

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    1. Ah so.. I see. The purchase price is in fact $2,400, and there is an option to sell it back to Smartmatic at $400. That’s the “explanation.” So who did the selling high and buying low? Not Juana Change the taxpayer.

      And why should Smartmatic store 75,000 machines somewhere? They could also sell them for souvenirs of the “great success,” or break them up for parts. Maybe the parts would be worth $4,500! Smartmatic should be commended for being so civic-minded, giving up all that profit by keeping things in storage.

      And Silliman University it is, not “Siliman.” And I never worked for the World Bank.

      Cheers!

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      1. Ahh so this is how you act when rattled by your own twisted take on things, very mature and professional. You obviously have a poor understanding even of the basics of a lease/sale transaction. But let me leave it at that and let your readers decide.

        And oh, I apologize for my wrong spelling and my bad, on World Bank. You were actually with the IMF. Now I know where you get your “smarts”, LOL!

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        1. Yes, let the readers decide who has “twists” and “rattles.” Sounds like a dance thing. Jessica Z would be honored.

          Many thanks for your apology and for visiting. Please consider FOO comment policy in future, especially the rule on bogus email addresses.

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      2. i think there IS a difference between purchase with the right to sell at a fixed price, and lease with the right to buy.

        for the former, if u are before the option expiry date, u may sell the pcos machines, while with the later u cannot.

        i do think that the price structure represents the fact that the value of the machine is in the first few months, although i’m not sure why the depreciation is so fast.

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        1. But the effect is the same, no? Let’s not talk about pcos machines. Say, I lease you a car for $2,000 for a month, and then for a year after you return it I give you a right to buy the same machine for $400. If you want to acquire it finally, you pay $2,400. Alternatively, I sell you the car for $2,400, but for a year from the sale, you have a put against me for $400. If you want to finally acquire the car, you also paid $2,400 because you don’t exercise the put.

          If all you wanted was to use the car for a month, you could do a lease and not exercise the call, and you pay $2,000. Or, you could buy for $2,400 and then sell it under the put for $400, and also you end up paying $2,000.

          Did I miss something?

          How much a thing depreciates depends on whether you can still use it and the value of that use. If Smartmatic intends to bid in future elections, perhaps the machine depreciates little. If not, but they can lease or sell it to another country or political entity, the machine can also depreciate only a little. But if technology makes the machine obsolete very fast, then there is no point storing it in any warehouse.

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        2. yes, but what if, within that month, the price of the car rises to say 3k, and possibly later in the month, falling to 2k.

          if u lease it, u cannot sell it, even if the price is high. u must wait till the end to buy it; by then the arbitrage is gone.

          if u buy it, u could sell it before the deadline (may technical term ito, i dont remember) of the option comes.

          thats the purpose of options, to hedge price fluctuations — but u can only do it (hedge) when u purchase.

          you said: “How much a thing depreciates depends on whether you can still use it and the value of that use…. But if technology makes the machine obsolete very fast, then there is no point storing it in any warehouse.”

          i agree, but the value of pcos is the software inside, which is upgradable quite fast. this should make the machine more valuable, not less. weird… unless optical scanning is a fast-churning industry in terms of technology… but 9 months from 2k to 400? not even CPUs depreciate that fast and they release new chips more than 2x a year (i guess).

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  3. @GabbyD:

    The previous commenter may have an explanation for how it can go from $2k to $400 in 9 months. My best quess is that the $2K includes accessory but proprietary software, but the $400 does not. It may have little to do with the issue of buy vs. lease, but more with what is being bundled at each stage of the contract. But I may well be wrong.

    Unless the hardware and OS architecture of the Smartmatic machine is “open,” I’m not sure that some other entity can easily upgrade the software the way cell phone shops can “open line” an initially “blocked” phone. Much probably depends on the fine print of the option to buy that Comelec has.

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