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Question - Jack Ltd. 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; it will provide $2.7 million in annual pretax cost savings. The system costs $9.4 million and will be depreciated straight-line to zero over its five-year life, after which it will be worthless. Jack Ltd. Has an effective tax rate of 23 percent and the firm can borrow at 9 percent. Panda Leasing Company has offered to lease the drilling equipment to Jack Ltd. for payments of $2.05 million per year. Panda's policy is to require its lessees to make payments at the start of the year.
(a) What is the net advantage to leasing (NAL) for Jack Ltd.?
(b) What is the maximum lease payment that would be acceptable to Jack Ltd.?
(c) Suppose Panda requires Jack Ltd. to pay a $1.5 million security deposit at the inception of the lease and Panda will refund the full security deposit at the end of the lease. Would Jack Ltd. still lease the equipment?
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