Utterby is considering the purchase of a new machine which would enable the company to cut annual salaries by £130,000 per year.

The machine would cost £480,000 if bought from the manufacturers, Fotherby. Annual service costs would be £14,500. The machine would need to be replaced after five years, but at that time could be sold on by Utterby for spare parts, yielding 2.5 per cent of the purchase price of the machine.

Fotherby has offered to lease the machine to Utterby for a lease payment of £98,000 per year, payable in advance at the start of each year. This lease payment would also cover service costs, with the lease contract renewable on an annual basis.

Utterby could finance the purchase of the machine by a medium-term bank loan at an interest rate of 11 per cent per year.

Utterby pays tax at a rate of 30 per cent per year, one year in arrears, and has been making a small profit after tax in each of the last two years. The company can claim 25 per cent reducing balance capital allowances on machinery.

(a) Using a present value analysis, calculate whether Utterby should buy or lease the new machine, considering:

(i) The case where tax benefits are considered; and

(ii) The case where tax benefits are ignored.

(b) Critically discuss the reasons why leasing has been a popular source of finance in recent years, illustrating your answer by referring to the information given.