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KEL217

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MARK JEFFERY

AMG, Inc. & Forsythe Solutions:

Lease vs. Buy Decisions

It was Monday morning and Adam Stolz’s first day at his new job at AMG, Inc. as controller
in the CFO’s office working with Brad Steiner, the information technology (IT) director. Stolz

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was in charge of a small team responsible for assessing the financial options of all IT projects in
excess of $1 million. As Stolz sat in his new office overlooking the Hudson River, he thought
back on his career and his rapid rise to this current position. Stolz had graduated from the Kellogg
School of Management just six years earlier. He started at AMG as a financial analyst in its
business solutions group. Stolz was quickly promoted to financial manager of the business
solutions group and garnered a reputation as a manager with a solid finance background and an
extraordinary eye for business strategy.
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He was jolted back to reality with a knock on his new office door—it was Steiner, and Stolz
could tell that something was worrying him. Steiner handed over a term sheet from Forsythe
Solutions outlining several options for leasing new personal computers (PCs) (see Exhibit 1).
Steiner briefly filled Stolz in on the problem and indicated that a recommendation was due on
Thursday for a meeting with the CFO and CIO.
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As Stolz looked at the Forsythe term sheet, he contemplated the problem Steiner had just
outlined. The IT department needed to roll out 7,542 new PCs. The rollout would occur over
twelve months, and all assets would be rolled out to multiple locations, as indicated in the
schedule Steiner had left on Stolz’s desk (see Exhibit 2). Each PC would cost $1,000, $750 for
hardware and $250 for software. All told, this was a more-than-$7.5 million technology financing
decision.

Stolz needed to determine if AMG should accept one of the leasing options from Forsythe
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Solutions or simply buy the PCs. He wanted to make a good impression on his new boss, but he
was not sure which deal to recommend for AMG or what terms to negotiate for a better deal.
Stolz realized he was going to need his team’s help.

AMG, Inc.
In 2001 AMG, Inc. was a Fortune 500 financial services company with $22 billion in annual
sales revenues. AMG operations were broken down into six business units: credit cards, personal
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loans, home loans, insurance, savings, and brokerage. AMG primarily serviced individuals and
small businesses.

©2006 by the Kellogg School of Management, Northwestern University. This case was prepared by H. Nevin Ekici ’03 and Cassidy
Shield ’02, in collaboration with Mike Conley at Forsythe Solutions Inc., under the supervision of Professor Mark Jeffery. Some facts
within the case have been altered for confidentiality reasons. Cases are developed solely as the basis for class discussion. Cases are not
intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. To order copies or
request permission to reproduce materials, call 800-545-7685 (or 617-783-7600 outside the United States or Canada) or e-mail
custserv@hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or
transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of
the Kellogg School of Management.
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 AMG, INC. & FORSYTHE SOLUTIONS KEL217

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AMG’s strategy was to provide all financial services required for individual consumers and

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small businesses. This was primarily accomplished through credit cards, loans, and other various
investment vehicles.

AMG operated in more than twenty locations in the United States, as well as most major
countries around the world. The weighted average cost of capital (WACC) for AMG was 15
percent, its tax rate was 34 percent, and its fiscal year started on January 1.

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Forsythe Technology
With $200 and a telephone on a dining room table as their office, Rick Forsythe and partner
Jim McArthur started a company in 1970 to sell and lease computers. By the end of the year they

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were in business with four customers. Incorporated in 1971, the partners bought an IBM 360
Model 30 from Comdisco and sold it to a subsidiary of Champion International. Later, they
bought an IBM 360 Model 50 and leased it to National Can. The company enjoyed the first of
thirty consecutive profitable years.

By the late 1970s the company had expanded to twenty employees, and McArthur sold his
half of the company to Forsythe. In the mid-1980s the company embarked upon an ambitious
five-year growth plan to triple earnings by 1990. In the same year, the company moved to what
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became its corporate headquarters in Skokie, Illinois, and opened four more offices. In the
following year, the company opened an East Coast regional office.

In 1989 and 1990 Forsythe McArthur earned the number one overall rating out of forty-six
leasing companies mentioned in Gartner Group’s IBM Large Computer Market service survey.
The company also won the “Spirit of Excellence” award from the Computer Dealers and Lessors
Association. In the same year, the company’s work force grew by 30 percent, and a San Francisco
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office—now the Western regional headquarters—was opened.

In the early 1990s Forsythe McArthur began to redefine itself as a value-added reseller,
establishing partnerships with many technology manufacturers. The company also added
technology consulting services to its offerings. In the mid-1990s the sales, distribution, and
consulting organization was renamed Forsythe Solutions Group. Forsythe Technology was
established as the parent company, and the Forsythe McArthur division continued to serve as the
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company’s financing and leasing arm.

Forsythe Technology experienced continued profitable growth, with revenues in 2000 of

$631 million. Forsythe celebrated its thirtieth anniversary in 2001 with 2,500 IT customers and
nearly 600 employees. Now entering its thirty-first year, Forsythe was the U.S. IT leasing market
leader (see the Forsythe Web site at www.forsythesolutions.com).

The AMG PC Rollout Schedule

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Exhibit 2 contains the AMG PC rollout schedule. The rollout schedule pertained to eight sites
in the United States. The 7,542 PCs were to be rolled out to these eight sites only. The leased and
purchased desktop breakout in the exhibit refers to the PCs targeted for replacement. At the time,
AMG had a combination of leased and purchased PCs. Going forward, AMG wanted to

2 KELLOGG SCHOOL OF MANAGEMENT

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 KEL217 AMG, INC. & FORSYTHE SOLUTIONS

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consolidate PC management into either leasing or buying all of its PCs. The rollout schedule was

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staggered in order to account for the limited IT support available to set up and configure the
systems and perform routine maintenance.

For lease evaluation purposes, assume the lease was to start at the beginning of the next
month. For example, 573 PCs were to be received in March; the lease on these PCs would start at
the beginning of April.

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For purchase evaluation, assume the PCs are purchased at the beginning of each month. For
example, the 573 PCs received in March were purchased at the beginning of March.

PC Depreciation and Salvage Value

Hardware

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Depreciation. The U.S. government tax code dictates the depreciation schedule for hardware
as five years, using the modified accelerated cost recovery system (MACRS) depreciation table in
Exhibit 3. AMG, Inc. used MACRS depreciation schedules for all PCs.
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Cost of Salvage. New Environmental Protection Agency (EPA) rules made the cost of
disposing of PCs $50 per PC, due to mercury in the monitor tubes. Another alternative was to sell
the PCs at the end of their useful life to employees for $50. From past experience, AMG had
found that 20 percent of their employees typically bought PCs in such an offering.

Software
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Purchased software is treated as a capital cost that is straight-line depreciated over five years.1
Software should be considered as having no value beyond what it was originally purchased for.
Once a license is purchased, it may not be sold or easily transferred.
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The Lease Quotes

Lease terms and conditions from Forsythe Solutions for two options are given in Exhibit 1.
The lease options consisted of a 24-month lease and a 36-month lease.

Each lease could be handled through one of two payment schedules: monthly takedowns
billed monthly and quarterly takedowns billed monthly. (A “takedown” is simply the number of
PCs put on lease in a given time period.)
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For a quarterly takedown, all of the PCs for a three-month quarter are put on a single-lease
contract starting at the end of that quarter. The leasing company then charges a prorated fee for

1
Tax laws change frequently and vary internationally. An assumption of straight-line depreciation for software over five years can be
used for the case.

KELLOGG SCHOOL OF MANAGEMENT 3

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 AMG, INC. & FORSYTHE SOLUTIONS KEL217

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each PC corresponding to the number of days or weeks from when the PC is delivered to the end

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of the quarter when the lease term starts. For AMG, all of the PCs in the rollout schedule in
Exhibit 2 would arrive on the first day of the month in the schedule.

In addition to the takedown structure, each lease could either be a rolling leaseline or a
coterminous leaseline.

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Rolling Lease

A rolling lease is defined as a lease that starts from the time each PC or group of PCs is taken
into possession and ends at a fixed time later. For example, a 24-month lease for five hundred
PCs starting in January 2002 would end at the end of December 2003, and a lease for six hundred
PCs starting in February 2002 would end at the end of January 2004. Consequently, the end of the

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lease agreements is staggered based on the rollout schedule.

Coterminous Lease

A coterminous lease is defined as a lease that ends on the same date for all PCs. Therefore, a
24-month lease that started in April would end at the end of March two years later. PCs that are
acquired in March would be leased for 24 months. PCs acquired in April would be leased for 23
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months and so on.

Leasing Options for AMG, Inc.

Exhibit 1 breaks down the lease options based on leaseline and takedown/billing options.
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Note that the software can be either leased or purchased. This was a decision that had to be taken
into account during the analysis.

Lease vs. Buy Decision

Stolz called Mike Conley, district manager at Forsythe, and asked him to explain the leasing
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terms. Mike explained that Forsythe’s equity insertion would be 10.1 percent for the 24-month
term and that Forsythe would take no equity in a 36-month deal.

Conley also explained that the financing rate for the PCs was determined by the bank’s
evaluation of AMG’s credit and ability to take on debt. AMG had good credit, and the determined
costs of capital were as follows:

36-month hardware: 8%
36-month software: 12%
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24-month hardware: 7%
24-month software: 11%

4 KELLOGG SCHOOL OF MANAGEMENT

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 KEL217 AMG, INC. & FORSYTHE SOLUTIONS

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To get an idea of the value of the PCs after 24 and 36 months, Stolz checked out

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www.bluebook.com. His best estimate was that a $750 PC would be worth approximately $150 in
24 months, and would be worth nothing in 36 months.

Stolz talked with the CFO, who indicated that this transaction should be kept off the balance
sheet. This made the decision a little easier, but he had several questions that remained to be
answered by his team. He still was not sure which leasing option and payment schedule to

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choose—or what the cost difference would be for leasing compared with purchasing the
computers.

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KELLOGG SCHOOL OF MANAGEMENT 5

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 AMG, INC. & FORSYTHE SOLUTIONS KEL217

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Exhibit 1: Forsythe Solutions Lease Quote

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Dear Brad,

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Thank you for your continued support of the Forsythe Solutions Group, Inc. (FSG). On behalf
of Forsythe McArthur Associates, Inc. (FMA), I am pleased to provide you with the following PC
leaseline proposal.

Equipment:
IBM Desktop PCs purchased through AMG, Inc.

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Leaseline Options:
36-Month Leaseline—Monthly or Quarterly Takedowns Billed Monthly
Hardware Lease Rate Factor: 0.0311, Software Lease Rate Factor: 0.0329

24-Month Leaseline—Monthly or Quarterly Takedowns Billed Monthly

Hardware Lease Rate Factor: 0.0400, Software Lease Rate Factor: 0.0462
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For all of the options, the leaseline can be either rolling or coterminous.

Please note all Lease Rate Factors listed are subject to adjustment based on the U.S. Treasury
Note at the time each schedule is put in place.

Sale and Lease Pricing is net of all applicable maintenance, freight, and tax charges.
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This proposal is subject to the proper execution of Forsythe McArthur’s standard form Master
Equipment Lease Agreement, Master Leaseline Agreement, and supporting documentation by
AMG, Inc. This proposal is also subject to FMA’s receipt and completed review of AMG, Inc.’s
audited financials.

Upon your signature below and upon the signature of a duly authorized officer of FSG in the
space set forth below acknowledging FSG’s acceptance and agreement hereto, this letter shall
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become a legally binding agreement incorporating the terms and conditions of Forsythe McArthur
Associates, Inc.’s standard form Master Equipment Lease Agreement. The undersigned
represents that he/she is duly authorized to execute this agreement on behalf of AMG, Inc. This
proposal is valid through March 31, 2002.

Thank you again for this opportunity, Brad. I look forward to reviewing this proposal with
you.

Regards,
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Forsythe Solutions Group, Inc.

Michael Conley
District Manager

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 AMG, INC. & FORSYTHE SOLUTIONS KEL217

Exhibit 2: PC Rollout Schedule for AMG, Inc. s t

2002 2003
Location March April May June July Aug Sept Oct Nov Dec Jan Feb Total/Location
Leased desktops
Seattle
Los Angeles 45 54
200
10
350
150 65 234
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123
554
681
Chicago 60 72 132
New York
Detroit
34 12
324
54 43
23
76 45
456
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231
267
1,034
Boston 32 45 65 4 146
Washington, DC 22 5 54 81
San Francisco 35 4 39

Purchased desktops
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Seattle 66 65 5 54 45 34 269
Los Angeles
Chicago
New York
123
32
200
32 56

2
34

234
34

12
py64

6
3 34

206
233

34
65

456
54

34
34

234
766
32
1,418
Detroit 5 350 3 6 364
Boston 10 5 7 56 42 243 324 687
Washington, DC
San Francisco
70 54 4
o 57
273 543
34
34 3 981
91

Total desktops/month 573 179 991 271 176 788 174 685 1,891 660 194 960 7,542
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 AMG, INC. & FORSYTHE SOLUTIONS KEL217

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Exhibit 3: MACRS Depreciation

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Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Value remaining (%) 100.00 80.00 48.00 28.80 17.28 5.76 0.00
Total depreciated (%) 0.00 20.00 52.00 71.20 82.72 94.24 100.00
Per year depreciated (%) 0.00 20.00 32.00 19.20 11.52 11.52 5.76

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35%
MACRS Depreciation (%)

30%

25%

20%

15%

10%

5%
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0%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Note: This depreciation schedule is for property placed in service halfway through the first year.
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8 KELLOGG SCHOOL OF MANAGEMENT

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