Big Sky Mining Company must install 1.5 million of new machinery it its Nevada m

Question

Big Sky Mining Company must install 1.5 million of new machinery it its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply:
(1)The machinery falls into the MACRS 3-year class.
(2)Under either the lease or the purchase, Big Sky must pay for insurance, propery taxes, and maintenance.
(3)The firms tax rate is 40%.
(4)The loan would have an interest rate of 15%.
(5)The lease terms call for $400,000 payments at the end of each of the next 4 years.
(6)Assume that Big Sky Mining has no use for the machine beyond the expiration of the lease. The machine has an estimated residual value of $250,000 at the end of the 4th year.
What is the NAL of the lease?

Explanation / Answer

NAL = Present Value of Purchasing – Present Value of Leasing

Purchase cost= 1500000+225000*$(Interest cost for 4 years)+0.4*1500000-250000=$2750000

Lease Cost=4*400000=$1600000

NAL=$1150000

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