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 $81,000 with a $7,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $31,000 per year. In addition, the equipment will have operating and energy costs of $7,840 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

Average investment = (81000 + 7000) / 2 = 88000 / 2 = 44000

Annual depritiation = (81000 - 7000) / 5 = 74000 / 5 = 14800

Saving in income = 31000 - 14800 - 7840 = 8360

Average rate of return = 8360 / 44000 = 19%

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