The Chevron 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 $1.5 million in annual pretax cost savings. The System cost $7 million and will be depreciated straight-line to zero over 5 years. Chevron's tax rate is 30 percent, and the firm can borrow at 10%. Lambert Leasing Company has offered to lease the drilling equipment to Chevron for payment of $1 650,000 per year. Lambert's policy requires its lessee to make payment at the start of the year.
What is the NAL for Chevron Company? What is the maximum lease payments that would be acceptable to the company?
Tip: The pretax cost savings are not relevant to the lease versus buy decision since the firm will definitely use the equipment and realize saving regardless of the financing choice made.