Big Sky Hospital plans to obtain a new MRI that costs $1.5 million and has an estimated four-year useful life. It can obtain a bank loan for the entire amount and buy the MRI, or it can obtain a guideline lease for the equipment. Assume that the following facts apply to the decision:

- The MRI falls into the three-year class for tax depreciation, so the MACRS allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1 through 4, respectively.

- Estimated maintenance expenses are $75,000 payable at the beginning of each year whether the MRI is leased or purchased.

- Big Sky's marginal tax rate is 40 percent.

- The bank loan would have an interest rate of 15 percent.

- If leased, the lease payments would be $400,000 payable at the end of each of the next four years.

- The estimated residual (and salvage) value is $250,000.

a. What are the NAL and IRR of the lease? Interpret each value.

b. Assume now that the salvage value estimate is $300,000, but all other facts remain the same. What is the new NAL? The new IRR?

(Hint: Use the following format as a guide.)

Year 0

Year 1

Year 2

Year 3

Year 4

Cost of owning:

Net purchase price

Maintenance cost

Maintenance tax savings

Depreciation tax savings

Residual value

Tax on residual value

Net cash flow

Cost of leasing:

Lease payment

Lease tax savings

Maintenance cost

Maintenance tax savings

Net cash flow

Net advantage to leasing:

PV cost of leasing

PV cost of owning

NAL