New Oil Co. is considering replacement of their highly specialised drilling equipment. The new equipment is computer assisted and therefore provides New Oil with $2.9 million in annual pre-tax savings. New Oil can purchase the equipment at $9.7 million which will be depreciated straight-line to zero over five years. The local bank is prepared to provide New Oil with $2.9 million loan at an interest rate of 9 percent with annual repayments spread over five years. Alternatively, New Oil can lease this equipment from ABC Leasing The lease contract will require an annual payment of $2.15 million per year payable at the beginning of each year for five years
a) Assuming a tax rate of 34% for New Oil, calculate the NAL of leasing rather than buying this equipment Should New Oil lease or buy this equipment? (10 marks)
b) What is the maximum lease payment that would be acceptable to New Oil? (3 marks)
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