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HealthPlan Northwest must install a new $1.5 million computer to track patient records in its three service areas. It plans to use the computer for only three years, at which time a brand new system will be acquired that will handle both billing and patient records. The company can obtain a 10 percent bank loan to buy the computer or it can lease the computer for three years.
Assume that the following facts apply to the decision:
The computer falls into the three-year class for tax depreciation, so MACRS allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1 through 4, respectively (yes, the 3-year class has 4 years...I find humor even in accounting).
The company's marginal tax rate is 34 percent.
Tentative lease terms call for payments of $480,000 at the end of each year.
The best estimate for the value of the computer after three years of wear and tear is $200,000.
Questions
a. What are the NAL and IRR of the lease? Interpret each value.
b. Assume now that the bank loan would cost 15 percent, but all other facts remain the same. What is the new NAL? The new IRR?
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