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 $123,000 with a $11,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $40,970 per year. In addition, the equipment will have operating and energy costs of $11,870 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. 5.45 X % Feedback Check My Work Divide the estimated average annual income by the average investment. Average savings less depreciation expense less additional operating costs equals average annual income.

Answer 1

Annual depreciation expense = (Cost price - Residual value)/Useful life

= (123,000 - 11,000)/5

= 112,000/5

= $22,400

Average annual income = Annual savings - Annual depreciation expense - Additional operating costs

= 40,970 - 22,400 - 11,870

= $6,700

Average investment = (Cost of equipment + Residual value)/2

= (123,000 + 11,000)/2

= 134,000/2

= $67,000

Average rate of return = Average annual income/Average investment

= 6,700/67,000

= 10%

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