Question
ABC 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
ABC 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. This system will provide $3 million in annual pre-tax cost savings. The system costs $10 million and will be depreciated straight-line to zero over five years. The company tax rate is 30%. The company can borrow at 10%. LLC Company has offered to lease the computer-assisted drilling system to ABC for payments of $2.1 million per year. LLC policy is to require its lessees to make payments at the beginning of the year.
(A). Calculate the maximum lease payment that would be acceptable to ABC.
(B) Calculate the maximum lease payment that would be acceptable to the company if the drilling system will have an after-tax residual value of $500,000 at the end of the lease period
(C)If LLC requires ABC to pay a $500,000 as a security deposit and the least payment is still $2.1 M, is it advantageous for ABC to lease the drilling system?
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