The ABC Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has already determined that acquisition of the system has a positive NPV. The system costs $9.4 million and will be depreciated straight-line to zero over 5 years. ABCs tax rate is 34 percent, and the firm can borrow at 9 percent. Southtown Leasing Company has offered to lease the drilling equipment to ABC for payments of $2.15 million per year. Southtown's policy is to require its lessees to make payments at the start of the year.

a. What is the NAL of leasing the equipment? (11 marks)

b. Comment on the following remarks: (9 marks)

I. Leasing reduces risk and can reduce a firms cost of capital.

II. Leasing provides 100% financing.

III. If the tax advantages of leasing were eliminated, leasing would disappear.