Southern Mfg. can save $950,000 in annual pretax costs by acquiring $2.6 million of new equipment that would be depreciated straight-line to zero over four years. Assume the equipment would have an aftertax residual value of $500,000 at the end of four years. Southern's tax rate is 23 percent and its pretax cost of debt is 9 percent. Lambert Leasing has offered to lease this equipment in exchange for annual payments which would be payable at the beginning of each year. What is the maximum lease payment that would be acceptable to Southern Mfg?

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The maximum lease payment that would be acceptable to Southern Mfg is $612,307. This is because the present value of the lease payments must be equal to the present value of the after-tax cost savings from acquiring the equipment. The present value of the lease payments is calculated as follows:PV = $612,307 * (1 - (1 + 0.09)^-4) / 0.09 = $2,100,000The present value of the after-tax cost savings is calculated as follows:PV = $950,000 * (1 - 0.23) * (1 + 0.09)^-1 + $950,000 * (1 - 0.23) * (1 + 0.09)^-2 + $950,000 * (1 - 0.23) * (1 + 0.09)^-3 + $950,000 * (1 - 0.23) * (1 + 0.09)^-4 + $500,000 * (1 - 0.23) * (1 + 0.09)^-4 = $2,100,000