Average Rate of Return-Cost Savings Midwest Fabricators Inc. is considering an i

Question

Average Rate of Return-Cost Savings Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $113,000 with a $10,000 residual value and a ten-year life. The equipment will replace one employee who has an average wage of $27,445 per year. In addition, the equipment will have operating and energy costs of $5,460 per year. Determine the average rate of return on the equipment, giving effect to straight-line depreciation on the investment. If required, round to the nearest whole percent.

Explanation / Answer

Annual Depreciation = ($113,000 - $10,000) / 10 = $10,300

Annual Net Income would increase = $27,445 - $5,460 - $10,300 = $11,685

Average Investment = ($113,000 + $10,000) / 2 = $61,500

Average rate of return = Annual Net Income would increase / Average Investment

Average rate of return = $11,685 / $61,500 = 19%

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