Kitchen Supplies Problem:

• Kitchen Supplies, Inc. must replace a machine in its manufacturing plant that will have no salvage value. It has a choice between two models. The company has already conducted a feasibility study at a cost of $3,000 to ensure that both models would work appropriately in place of the old machine. The study indicated no problems.
• The first machine will last five years and will cost $300,000. It will generate an annual cost savings of $50,000. Annual maintenance costs will start at $15,000 per year and increase at a 10% rate. The machine will be depreciated straight-line over five years to a book value of $50,000. At the end of five years, the machine can be expected to be sold at $40,000. Financing costs per year would be approximately $5,000 per year.
• The second machine will last seven years and will cost $600,000. It will generate an annual cost savings of $70,000. The annual maintenance costs will start at $20,000 per year and increase at a 8% rate. The machine will be fully depreciated using the straight-line depreciation method to a book value of zero, but is expected to have a market value of $60,000 at the end of the seventh year.
• The annual tax rate is 35% and the cost of capital is 10%.

Which machine should the company purchase? Back up your answer with the appropriate calculations.