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 $117,000 with a $10,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $42,900 per year. In addition, the equipment will have operating and energy costs of $11,340 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 = (117000-10000)/5 = 21,400

Annual Net Income = $42,900 - ($21,400 +$11,340) = 10,200

Average Investment = (117000+10000)/2 = 63,500

Average rate of return = Annual Net Income/ Average Investment

Average rate of return = 10200/63,500

Average rate of return = 16%

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