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NAL and IRR of the lease

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Big Sky Hospital plans to obtain a new MRI that costs $1.5 million and has an estimated four-year useful life. It can obtain a bank loan for the entire amount and buy the MRI or it can lease the equipment. Assume that the following facts apply to the decision:

- The MRI falls into the three-year class for tax depreciation, so the MACRS allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1 through 4, respectively.

- Estimated maintenance expenses are $75,000 payable at the beginning of each year whether the MRI is leased or purchased.
- Big Sky's marginal tax rate is 40 percent.
- The bank loan would have an interest rate of 15 percent.
- If leased, the lease (rental) payments would be $400,000 payable at the end of each of the next four years.

- The estimated residual (and salvage) value is $250,000.

a. What are the NAL and IRR of the lease? Interpret each value.
b. Assume now that the salvage value estimate is $300,000, but all other facts remain the same. What is the new NAL? The new IRR?

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Solution Summary

The solution explains how to calculate the NAL and IRR of the lease

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HealthPlan Northwest's new computer system: NAL and IRR of the lease

HealthPlan Northwest must install a new $1 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 the MACRS allowances are 0.33, 0.45, 0.15, and 0.07 in Years 1 through 4, respectively.
- The company's marginal tax rate is 34 percent.
-Tentative lease terms call for payments of $320,000 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.

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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