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 $9.9 million and will be depreciated straight-line to zero over 5 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 $2.21 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? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Negative amount should be indicated by a minus sign.)

What is the maximum lease payment that would be acceptable to the company? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your 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 $2.7 million in annual pretax cost savings. The system costs $9.9 million and will be depreciated straight-line to zero over 5 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 $2.21 million per year. Lambert's policy is to require its lessees to make payments at the start of the year.

Explanation / Answer

Ther pre cost savings is not relevant for us because regardless of what decision is made company will generate this revenue. Importance is of depreciation shield. If compnay leases the equipment it will loss depreciation shield

Depreciation shield = (9900000/5)*34% = 6,73,200$

After tax lease payment = 2210000(1-0.34) = 14,58,600$

After tax cost of debt = 8%(1-0.34) = 5.28%

NAL = $9900000-1458600 - 1458600*PVIFA(5.28%,4year) -673200*PVIFA(5.28%,4 year)

=8441400-(1458600*3.523)-(673200*4.296)

=8441400-5138660-2892182

=$410558.44

Thus machine should be leased

To find out maximum payment, we find where NAL is equal to zero, and solve for payment, using X to represent minimum payment

NAL=0=9900000-X(1.0528)(PVIFA(5.28%,5years) - 673200*PVIFA(5.28%,5years)

=0=9900000-X(1.0528)(4.29617) -673200*4.29617

=-9900000=-4.523X - 2892182

=7007818=4.523X

X=1549371$

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