Pocket Pilot Inc. is considering an investment in new equipment that will be use

Question

Pocket Pilot Inc. is considering an investment in new equipment that will be used to manufacture a mobile communications device. The device is expected to generate additional annual sales of 6,300 units at $292.00 per unit. The equipment has a cost of $703,100, residual value of $52,900, and an eight-year life. The equipment can only be used to manufacture the device. The cost to manufacture the device is shown below.

Determine the average rate of return on the equipment. If required, round to the nearest whole percent

Cost per unit: Direct labor $48.00 Direct materials 186.00 Factory overhead (including depreciation) 31.60 Total cost per unit $265.60

Explanation / Answer

Incremental revenue form the sale of additional 6300 units = 6300 units * $292 per unit = $1839600

Incremental cost = 6300 units * $265 / unit = $ 1669500

Incremental annual income = $1839600 - $ 1669500 = $ 170100

Average investment = (703100 + 52900) / 2 = $378000

Average Rate of return on the equipment

= Average annual accounting income / Average investment

= $170100 / $378000

= 45%

Note: In absence of information it has been assumed that the fixed cost has been incurred for the production of the additional units.

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