Cost of Financing vs. Cost of Waiting Explained
In an attempt to be conservative with budgets, many local governments delay buying new trucks and equipment for as long as possible to avoid the cost of interest associated with a loan. Few recognize that there is a cost of waiting to consider as well. The reality of the situation is that the inflation on capital equipment normally outpaces the tax-exempt interest rates found in most local government lease financing.
To understand this, consider that the purchase price of new trucks has been increasing due to higher material costs and changes in standards. It has been running higher over the last 10 years, but lets assume we estimate this increase to average 4% per year. The inflation identified above would cause a $250,000 truck to increase to $304,163 in five years – a $54,163 increase. At the same time, if you finance that $250,000 truck today, you will pay $22,083 in interest over the same 5 year period. Inflation applies to the entire truck price, while interest applies only to the unpaid balance which is decreasing.
So there is a cost to financing, and a cost to waiting. It is easy to see why it is prudent to consider both costs. Interest cost of $22,083 is a good thing if it avoids the larger inflation cost of $54,163.