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 $1.9 million in annual pretax cost savings. The system costs $8.6 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 $2.15 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 $1.9 million in annual pretax cost savings. The system costs $8.6 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 $2.15 million per year. Lambert's policy is to require its lessees to make payments at the start of the year.

Explanation / Answer

AMOUNT IN LAKHS

HENCE COST OF BORROWING IS MORE ADVANTAGE THEN COST OF LEASING, AS COST OF BORROWING GENERATING POSITIVE CASH FLOW.

cost of borrowing in lakhs years 0 1 2 3 4 5 buy (outfow 86 annual saving 19 19 19 19 19 dep 17.2 17.2 17.2 17.2 17.2 interest @ 8% 6.88 6.88 6.88 6.88 6.88 PBT -5.08 -5.08 -5.08 -5.08 -5.08 TAX 34% -1.73 -1.73 -1.73 -1.73 -1.73 PAT -3.35 -3.35 -3.35 -3.35 -3.35 add dep 17.2 17.2 17.2 17.2 17.2 profit 13.85 13.85 13.85 13.85 13.85 PV @ 8% 0.926 0.857 0.794 0.735 0.68 12.82 11.87 10.99 10.18 9.416 total outflow = 86 total inflow = 55 net saving = 31

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