The Wildcat Oil Company is trying to decide whether to lease or buy a new comput

Question

The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $2.7 million in annual pretax cost savings. The system costs $9.4 million and will be depreciated straight-line to zero over five years. Wildcat's tax rate is 34 percent, and the firm can borrow at 9 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $2.15 million per year. Lambert's policy is to require its lessees to make payments at the start of the year.

What is the NAL for Wildcat? What is the maximum lease payment that would be acceptable to the company?

Explanation / Answer

if they purchase the machine then the costs associated with these are:

cost= $9,400,000 and benefits are $2,700,000 for 5 years

the total cost of borrwoing for 5 years= 9,400,000(0.09)= 846000*5= $4,230,000

total cost= 9,400,000+4,230,000=$13,630,000/5= $2,726,000 per annum

the leasing cost is $2,150,000 which is lesser than cost of buying it.

so, leasing is better option.

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