Your business needs a piece of equipment. Which is the best way to acquire it?
 
  A) Pay cash
  B) Steal it
  C) Borrow
  D) Lease
 
  Option A, paying cash, has obvious appeal. You don't have to go through the process of making a financing request from a bank or leasing company, and, more importantly, you won't have to pay all that nasty interest. Paying cash for the equipment isn't nearly as costly as borrowing or leasing. (It is, however, more expensive than stealing.)
 
  But the astute businessperson realizes that paying cash actually can be more expensive than borrowing or leasing.
 
  How can paying interest on borrowed money be cheaper than using your own money? Relax, gentle reader. The cool, calm and collected columnist of capital will explain. It will become perfectly clear to you.
 
  If your company has sufficient cash on hand to pay for the needed equipment, and your company won't need that cash during the economic life of the equipment, then the cash used to acquire the equipment can be deemed part of your company's equity. And, as faithful readers of this column know from mind-numbing repetition, equity is not free and is more expensive than debt because it is riskier than debt.
 
  To illustrate this, look at Anheuser-Busch Cos. Inc., which is one of the most successful and profitable companies in the world. This company, which makes barrels of money by fulfilling the often-expressed desire that "I need a beer,'' computes its cost of debt capital at 5.2 percent and its cost of equity capital at 14.3 percent.
 
  Assume that the risk your company presents to your shareholders is slightly higher than the risk offered by Anheuser-Busch. Your shareholders want to earn 15 percent per year on their investment, and your firm can borrow money from a financial institution at 10 percent per year. That is, your company must generate at least a 15 percent after-tax return on equity each year, and your company's cost of debt is 10 percent.
 
  In order to simplify the analysis, let's further assume that your company's incremental cost of equity also is 15 percent and the incremental cost of debt also is 10 percent.
 
  Because dividends are paid out to shareholders with after-tax dollars (and earnings retained also are in after-tax dollars), the after-tax cost of your company's equity is 15 percent. However, since interest payments are tax-deductible, the after-tax cost of your debt is not 10 percent. Assuming your company is in the 25 percent marginal tax bracket, every dollar in interest reduces your taxes by 25 cents. So, the after-tax cost of debt is actually 7.5 percent (which is one minus the marginal tax rate, times the interest rate).
 
  So now you're faced with the decision of whether to fund the needed equipment with equity that will cost you 15 percent per year, or fund it with debt that will cost you 7.5 percent per year.
 
  Let's not waste any valuable time consulting a rocket scientist on this one. Using the assumptions noted above, it seems pretty clear that paying cash for the equipment is not the financially prudent move.
 
  Option B - stealing it - seems absolutely ludicrous, and, therefore, this columnist must be joking. Well, that's only partially true, because I'm half joking.

 

  Think about the number of times your company, or another firm you know, has agreed to sell something to a customer. The seller and buyer agree on all the specifications, and terms and conditions of the sale. The goods are delivered by the seller, the goods are satisfactory to the buyer, and payment becomes due on the stipulated date.