3. 8.

Deposits in leasing [LO 27.3] Many lessors require a security deposit in the form of a cash payment or other pledged collateral. Suppose Lambert requires Wildcat to pay a $600 000 security deposit at the inception of the lease. If the lease payment is still $1.625 million, is it advantageous for Wildcat to lease the equipment now? 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 $2.3 million in annual pretax cost savings. The system costs

$7.3 million and will be depreciated straight-line to zero over five years.

Wildcat’s tax rate is30 per cent, and the firm can borrow at 7 per cent.

Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $1.625 million per year. Lambert’s policy is to require its lessees to make payments at the start of the year.