Chapter 21, Problem 10QP

Use the following information to work Problems 9-11. 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 $2.9 million in annual pretax cost savings. The system costs $9.7 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 9 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.

10. Leasing and Salvage Value Suppose it is estimated that the equipment will have an aftertax residual value of $700,000 at the end of the lease. What is the maximum lease payment acceptable to Wildcat now?