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

Please clarify the NAL and maximum lease payment.

Explanation / Answer

1

Calculation of Net Advantage of Leasing (NAL)

Present value of Costs in Lease option :

$ Million

Lease Rental (Net of tax)

1.419

2.15* (1-0.34)

PVF (9%, 5 Years)

   4.23972

Present value

          6.02

Present value of Costs in Buy option :

$ Million

Initial Cost of Machine

9.4

Less: Tax Saving on depreciation

Annual Depreciation (9.4/5)

1.88

Annual Tax Saving = 1.88 *35%

0.658

PVF (9%, 5 Years)

    4.23972

Present value of tax Saving

($2.79)

Present value of Costs in Buy option :

          6.61

Net Advantage of leasing (NAL) = 6.61 -6.02

          0.59

2

Calculation of Maximum lease payment

Maximum lease payment shall be that amount at which the present value of lease any buy option are equal

Lets Say maximum lease payment is X per annum

Hence ,

X * (1-0.35) *4.23972 = 6.61

X *0.65 = 6.61 / 4.23972

X = 2.40

Hence Maximum lease payment shall be $2.40 Million Per year

1

Calculation of Net Advantage of Leasing (NAL)

Present value of Costs in Lease option :

$ Million

Lease Rental (Net of tax)

1.419

2.15* (1-0.34)

PVF (9%, 5 Years)

   4.23972

Present value

          6.02

Present value of Costs in Buy option :

$ Million

Initial Cost of Machine

9.4

Less: Tax Saving on depreciation

Annual Depreciation (9.4/5)

1.88

Annual Tax Saving = 1.88 *35%

0.658

PVF (9%, 5 Years)

    4.23972

Present value of tax Saving

($2.79)

Present value of Costs in Buy option :

          6.61

Net Advantage of leasing (NAL) = 6.61 -6.02

          0.59

2

Calculation of Maximum lease payment

Maximum lease payment shall be that amount at which the present value of lease any buy option are equal

Lets Say maximum lease payment is X per annum

Hence ,

X * (1-0.35) *4.23972 = 6.61

X *0.65 = 6.61 / 4.23972

X = 2.40

Hence Maximum lease payment shall be $2.40 Million Per year

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.