Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply.
(1) The machinery falls into the MACRS 3-year class.
(2) Under either the lease or the purchase, Big Sky must pay for insurance, property taxes, and maintenance.
(3) The firm’s tax rate is 25%.
(4) The loan would have an interest rate of 15%. It would be nonamortizing, with only interest paid at the end of each year for four years and the principal repaid at Year 4.
(5) The lease terms call for $400,000 payments at the end of each of the next 4 years.
(6) Big Sky Mining has no use for the machine beyond the expiration of the lease, and the machine has an estimated residual value of $250,000 at the end of the 4th year.
a. What is the cost of owning?
b. What is the cost of leasing?
c. What is the NAL of the lease?