After analyzing a five-year project using the NPV criterion, you, the financial manager of Firesale Oil Drilling

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Question:

After analyzing a five-year project using the NPV criterion, you, the financial manager of Firesale Oil Drilling Inc., have decided to go ahead with the proposed project and purchase equipment costing $1.45 million. The project will yield incremental pre-tax cash inflows of $350,000 per year for the next five years. The equipment belongs to the asset class with a CCA rate of 30%, and the equipment will be worthless at the end of the project's life. The asset class will remain open after the end of the project. Firesale can borrow the $1.45 million from the Royal Canadian Bank at 10% compounded annually. The company's marginal corporate tax rate is 35%.

Before purchasing the equipment, you decide that it might be worthwhile to check out the leasing alternative. You contact the manager of We-Lease-It-All Corp. and obtain the following quote:

Lease term: five years
Lease payment: $375,000 per year
Lease payment due: beginning of each year

You will have to decide whether you should lease or buy the equipment based on the available information.

Describe the steps you would take to calculate the break-even lease payment for Firesale. You do not have to perform the calculations in this question. Simply discuss the requisite steps.