Mila Limited (ML) is considering whether to lease or purchase a piece of equipment. The following information is relevant to these options: Buy: The purchase price of the machine is $7 million. The machine would be straight-line depreciated to a zero salvage value over 6 years. The residual value is expected to be zero. Lease: The annual lease payments requested by Michal Leasing Inc. (the lessor) would be $3 million, payable at the end of each of the 3 years of the lease. 

 

Additional information: Corporate tax rate is 45% for both companies, the cost of equity for ML is 15%, the cost of secured debt for ML is 13% and its WACC is 18%. The cost of secured debt for Michal Leasing Inc. is 7%. 

(a) Does the fact that the lessor and lessee have different borrowing rates affect the calculation of the NAL? Briefly explain your answer. (2 marks) 

(b) Would such lease be classified as capital or an operating lease? Briefly explain.