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 $2.1 million in annual pretax cost savings. The system costs $8.8 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 8 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $2.25 million per year. Lambert's policy is to require its lessees to make payments at the start of the year.

Many lessors require a security deposit in the form of a cash payment or other pledged collateral. Suppose Lambert requires Wildcat to pay a $800,000 security deposit at the inception of the lease.

Calculate the NAL with the security deposit. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

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 $2.1 million in annual pretax cost savings. The system costs $8.8 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 8 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $2.25 million per year. Lambert's policy is to require its lessees to make payments at the start of the year.

Explanation / Answer

After tax lease payments = (1 - 34%) * 2.25 * 10^6 = 1485000

Depreciation tax shield = 34% * (8.8 / 5) * 10^6 = 598400

After tax rate = 8% * (1-34%) = 5.28%

NAL

   = 8800000 -1485000 - 1485000*PV(5.28%, 4, -1) - 598400*PV(5.28%, 5, -1) - 800000 + 800000*PV(5.28%,5, ,-1)

NAL = 8800000 -1485000 - 1485000*3.52 - 598400*4.30 - 800000 + 800000*0.77

NAL = -668965.49

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