Chapter 21, Problem 11QP

Use the following information to work Problems 9-11. The Wildcat Oil Company 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 $2.9 million in annual pretax cost savings. The system costs $9.7 million and will be depreciated straight-line to zero over five years. Wildcat’s tax rate is 34 percent and the firm can borrow at 9 percent. Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $2.15 million per year. Lambert’s policy is to require its lessees to make payments at the start of the year.

11. Deposits in Leasing Many lessors require a security deposit in the form of a cash payment or other pledged collateral Suppose Lambert requires Wildcat to pay a $1.5 million security deposit at the inception of the lease. If the lease payment is still $2.15 million, is it advantageous for Wildcat to lease the equipment now?