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What is the net cost of leasing

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Reference no: EM132713235

OLG Inc has to install a sophisticated deep hole drilling machine manufactured by PreHole for the oil extraction business. OLG can buy this machine from PreHole. It can obtain a bank loan at 12% interest rate for 100% of the purchase price. PreHole also offers lease option. The tax rate applicable to OLG is 40%. Now, OLG need to determine whether it wants to purchase or lease the required machine.

Additional information provided below:

Cost of the machine (in $ million): $102
Life of the machine is 10 years

  • The machine will be fully depreciated over its useful life but can be scrapped at $5m at the end of 10 year. If OLG chooses to lease the machine, PreHole is responsible for the maintenance cost which is estimated to be $2m per year. However, OLG need to bear this cost if the machine owned.

Annual lease payment (payable at the end, amount in $ million): $19

Determine the relevant cashflow for lease vs buy decision and answer the following questions:

Problem a. What is the net cost of leasing?

Problem b. What is the net cost of buying?

Problem c. What is the NPV of Leasing or NAL?

Problem d. What should be the competitive lease amount given that both OLG and PreHole have the same borrowing rate and tax rate?

Reference no: EM132713235

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