The Wildcat Oil Company is trying to decide whether to lease or buy a new comput
ID: 2754835 • Letter: T
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 $2.4 million in annual pretax cost savings. The system costs $9.1 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's policy is to require its lessees to make payments at the start of the year.
Suppose it is estimated that the equipment will have an aftertax residual value of $900,000 at the end of the lease. What is the maximum lease payment acceptable to Wildcat? (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 $2.4 million in annual pretax cost savings. The system costs $9.1 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's policy is to require its lessees to make payments at the start of the year.
Explanation / Answer
Part 1 Years Cash flows Dep Cash flow after dep Tax Cash flow after dep Dep Cash flow after tax before dep PV @8% present value 0 9100000 34% 1 2400000 1820000 580000 197200 382800 1820000 2202800 0.925926 2039630 2 2400000 1820000 580000 197200 382800 1820000 2202800 0.857339 1888546 3 2400000 1820000 580000 197200 382800 1820000 2202800 0.793832 1748654 4 2400000 1820000 580000 197200 382800 1820000 2202800 0.73503 1619124 5 2400000 1820000 580000 197200 382800 1820000 2202800 0.680583 1499189 Present value of cash inflow 8795142 cash Outflow 9100000 NPV of the Project -304858 IRR of the Project 6.76% IRR is the rate at which NPV of the project is Zero Decision : company's IRR rate is 6.76% at which NPV of the Project is Zero which is less than the required minimum rate of return of 8% so company should not accept this project. Rough Work 2202800 0.909091 2002545 2202800 0.826446 1820496 2202800 0.751315 1654996 2202800 0.683013 1504542 900000 2202800 0.620921 1926595 8909174 9100000 -190826 0.617193 498492 2 1.234387 8 9.234387 Part 2 Years Dep Tax Dep PV @8% 0 9100000 34% 1 2400000 1820000 580000 197200 382800 1820000 2202800 0.925926 2039630 2 2400000 1820000 580000 197200 382800 1820000 2202800 0.857339 1888546 3 2400000 1820000 580000 197200 382800 1820000 2202800 0.793832 1748654 4 2400000 1820000 580000 197200 382800 1820000 2202800 0.73503 1619124 5 2400000 1820000 580000 197200 382800 1820000 2202800 0.680583 1499189 5 900000 900000 0.680583 612524.9 Present value of cash inflow 9407667 cash Outflow 9100000 NPV of the Project 307666.5 IRR of the Project 9.23% Maximum Amount = 9100000*9.23% Maximum amount of Lease 839930 Company can pay maximum 839930 as a maximum amount for lease as IRR is 9.23% and cost of capital is 8%
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