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