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 $550,000 in annual pretax cost
savings. The system costs $3 million and will be depreciated straight-line to zero over 4
years. It is estimated that the equipment will have an aftertax residual value of $500,000
at then end of the lease. Wildcat's tax rate is 31 percent, and the firm can borrow at 10
percent. Lambert Leasing Company has offered to lease the drilling equipment to
Wildcat for payments of $940,000 per year. Lambert's policy is to require its lessees to
make payments at the start of the year. What is the maximum lease payment that would
be acceptable to the company?
The discount rate assigned to an individual project should be based on:
A. the firm's weighted average cost of capital.
B. the actual sources of funding used for the project.
C. an average of the firm's overall cost of capital for the past five years.
D. the current risk level of the overall firm.
E. the risks associated with the use of the funds required by the project.