Average Rate of Return—Cost Savings Master Fab Inc. is considering an investment

Question

Average Rate of Return—Cost Savings Master Fab Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $103,000 with a $9,000 residual value and a 10-year life. The equipment will replace one employee who has an average wage of $19,980 per year. In addition, the equipment will have operating and energy costs of $4,980 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

1) Calculation of Average rate of return :

Annual depreciation = ($103,000 - $9,000) / 10 years

= $9,400

Annual savings due to the machine = $19,980 - $4,980 - $9,400

= $5,600

Average rate of return = $5,600 / $103,000

= 5.44%

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