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 $5 million in annual pretax cost savings. The system costs $10 million and will be depreciated straight-line to zero over five years. The market value of the retired system is $2 million. Wildcat’s tax rate is 40 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 million per year. Lambert’s policy is to require its lessees to make payments at the start of the year in the five-year lease period. The lessor also requires a security deposit of $1.5 million in the form of a cash payment at the inception of the lease. The deposit is returned to the lessee at the end of the leasing contract (the end of year 5). What is the NAL of the lease?

a. 0.54

b. 0.11

c. 0.12

d. 0.23

Answer 1