2.99 See Answer

Question: The Wildcat Oil Company is trying to

The Wildcat Oil Company is trying to decide whether to lease or buy a new computerassisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $2.8 million in annual pretax cost savings. The system costs $8.78 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 7 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $1.95 million per year. Lambert’s policy is to require its lessees to make payments at the start of the year.
An asset costs $745,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 6 percent and the lessee can borrow at 9 percent. The corporate tax rate is 21 percent for both companies.
a. How does the fact that the lessor and lessee have different borrowing rates affect
the calculation of the NAL?
b. What set of lease payments will make the lessee and the lessor equally well off?
c. Assume that the lessee pays no taxes and the lessor is in the 21 percent tax bracket. For what range of lease payments does the lease have a positive NPV for both parties?


See Answer