Big Sky Hospital plans to obtain a new MRI that costs $2.5 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 $175,000 payable at the beginning of each year whether the MRI is leased or purchased.
-Big Sky's marginal tax rate is 35 percent.
-The bank loan would have an interest rate of 15 percent.
-If leased, the lease (rental) payments would be $750,000 payable at the end of each of the next four years.
-The estimated residual (and salvage) value is $500,000.
a. What are the NAL and IRR of the lease? Interpret each value.
b. Should Big Sky Hospital lease or buy?
c. 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?
d. Did the new salvage value estimate change the decision to lease or buy?