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 $850,000 in annual pretax cost savings. The system costs $8 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 $2,040,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company?
The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.
Depreciation tax shield lost = ($8,000,000/5) (0.34) = $544,000 Aftertax debt cost = 0.08 (1 - 0.34) = 0.0528 NAL = 0 = $8,000,000 - X (1.0528) (PVIFA5.28%, 5) - $544,000(PVIFA5.28%, 5); X = $1,252,017.09 Pretax lease payment = $1,252,017.09/(1 - 0.34) = $1,896,996 |
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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 $550,000 in annual pretax cost savings. The system costs $3 million and will be depreciated straight-line to zero over 4 years. It is estimated that the equipment will have an aftertax residual value of $500,000 at then end of the lease. Wildcat's tax rate is 31 percent, and the firm can borrow at 10 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $940,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. What is the maximum lease payment that would be acceptable to the company?
The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.
Depreciation tax shield lost = ($3,000,000/4) (0.31) = $232,500 Aftertax debt cost = 0.1 (1 - 0.31) = 0.069 NAL = 0 = $3,000,000 - X (1.069) (PVIFA6.9%, 4) - $232,500(PVIFA6.9%, 4) - $500,000/1.0694; X = $503,652.75 Pretax lease payment = $503,652.75/(1 - 0.31) = $729,932 |
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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 $1.2 million in annual pretax cost savings. The system costs $6.7 million and will be depreciated straight-line to zero over 4 years. Wildcat's tax rate is 35 percent, and the firm can borrow at 11 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $1,700,000 per year. Lambert's policy is to require its lessees to make payments at the start of the year. Lambert requires Wildcat to pay a $270,000 security deposit at the inception of the lease. What is the NAL of leasing the equipment?
The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize the savings regardless of the financing choice made.
Depreciation tax shield lost = ($6,700,000/4) (0.35) = $586,250 Aftertax lease payment = $1,700,000 (1 - 0.35) = $1,105,000 Aftertax debt cost = 0.11 (1 - 0.35) = 0.0715 The security deposit is a cash outflow at the beginning of the lease and a cash inflow at the end of the lease when it is returned. NAL = $6,700,000 - $270,000 - $1,105,000 - $1,105,000 (PVIFA7.15%, 3) - $586,250(PVIFA7.15%, 4) + $270,000/1.07154 NAL = $658,844 |
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An asset costs $420,000 and will be depreciated in a straight-line manner over its 3-year life. It will have no salvage value. The corporate tax rate is 32 percent, and the cost of borrowing is 8 percent. What lease payment amount will make the lessee and the lessor equally well off?
Depreciation tax shield = ($420,000/3) (0.32) = $44,800
Aftertax debt cost = 0.08(1 - 0.32) = 0.0544 NAL = 0 = $420,000 - PMT (1 - 0.32) (PVIFA5.44%,3) - $44,800(PVIFA5.44%,3); PMT = $162,795.34 |
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