7 Amalgamated Effluents plc, a chemical company currently in legal difficulties over its pollution record, is considering a proposal to acquire new equipment to improve waste generation. The equipment would cost £500,000 and have a working life of four years. At the end of Year 4, the disposal value of the equipment is expected to be £50,000. The machine is expected to generate incremental cash flows of £200,000 for each of the four years.

Amalgamated can acquire the equipment in two ways:

(a) Outright purchase via a four-year bank loan at a pre-tax interest cost of 7 per cent.

(b) A financial lease with rentals of £70,000 at the end of each of the four years.

Amalgamated is presently ungeared. Its shareholders seek a return of 10 per cent after allowing for all taxes. Corporation Tax is paid at 30 per cent with no tax delay. If the equipment is purchased, a 25 per cent writing-down allowance (reducing balance) is available.

Required Should Amalgamated acquire the equipment and, if so, how should it be financed?