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 $4.6 million in annual pretax cost savings. The system costs $9.6 million and will be depreciated straight-line to zero over five years. Wildcat’s tax rate is 21 percent and the firm can borrow at 9 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 $1,020,000 at the end of the lease.

What is the maximum lease payment acceptable to Wildcat? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)

Answer 1

	Inputs	Tax rate	21%		Interest rate	9%
		Dep rate	20%
		(Since Straight line Method for 5 Years)
Year	Savings	Depreciation	Interest	Net Income (Before tax)	Tax @21%	Net saving After Tax	Depreciation	Cash Flow
	A	B	C	D	E	F= (D-E)		G=(F+B)
1	4600000	1920000	864000	1816000	381360	1434640	1920000	3354640
2	4600000	1920000	691200	1988800	417648	1571152	1920000	3491152
3	4600000	1920000	518400	2161600	453936	1707664	1920000	3627664
4	4600000	1920000	345600	2334400	490224	1844176	1920000	3764176
5	4600000	1920000	172800	2507200	526512	1980688	1920000	3900688
Calculation of NPV
Cash Outflow	Machiney						A	9600000
								9600000
Cash Inflow
	Cash Inflow	Loan Repayment	Slavage Value (Net of tax) (1020000*.79)			Net Inflow	Discounting Factor @9%
						0	1	-
1	3354640	-1920000				1434640	0.9174	1,316,183.49
2	3491152	-1920000				1571152	0.8417	1,322,407.20
3	3627664	-1920000				1707664	0.7722	1,318,629.93
4	3764176	-1920000				1844176	0.7084	1,306,460.77
5	3900688	-1920000	805800			2786488	0.6499	1,811,026.01
								7,074,707.40
NPV of the Project is								(2,525,292.60)
Lease	Savings'	Lease Payment*	Net	Tax		Net Cash outflow	Discounting Factor @9%
	A	B	C=A-B	D		(C-D)
0	4,600,000.00	(5,353,958.52)	(753,958.52)	(158,331.29)		(595,627.23)	1.0000	(595,627.23)
1	4,600,000.00	(5,353,958.52)	(753,958.52)	(158,331.29)		(595,627.23)	0.9174	(546,447.00)
2	4,600,000.00	(5,353,958.52)	(753,958.52)	(158,331.29)		(595,627.23)	0.8417	(501,327.52)
3	4,600,000.00	(5,353,958.52)	(753,958.52)	(158,331.29)		(595,627.23)	0.7722	(459,933.51)
4	4,600,000.00	(5,353,958.52)	(753,958.52)	(158,331.29)		(595,627.23)	0.7084	(421,957.34)
	* Based on Trial & Errorr							(2,525,292.60)
	The Lease rental of 5353958.52 should be acceptable to Wildcat