Question

The following data are accumulated by Lone Peak Inc. in evaluating two competing capital investment proposals:

	3D Printer		Truck
Amount of investment	$60,000			$40,000
Useful life	4 years			7 years
Estimated residual value	0			0
Estimated total income over the useful life	$5,400			$12,600

Determine the expected average rate of return for each proposal. If required, round your answers to one decimal place.

3D Printer	%
Truck	%

Answer 1

Solution :

The Average Rate of Return is calculated using the formula

= Annual Net Income / Average Investment

Calculation of Average Rate of Return of 3D Printer:

As per the information given in the question we have

Estimated total income over the useful life = $ 5,400

Useful Life = 4 years

Thus the Annual Net Income = Amount of investment / Useful Life

= $ 5,400 / 4 = $ 1,350

Amount of investment = $ 60,000

Estimated residual value = $ 0

We know that the Average Investment = ( Initial Investment + Residual value ) / 2

Applying the above information in the formula we have

= ( $ 60,000 + $ 0 ) / 2

= $ 60,000 /2

= $ 30,000

Thus the Average Investment = $ 30,000

Applying the available information in the formula for Average Rate of return we have

= $ 1,350 / $ 30,000

= 0.045

= 4.5 %

Thus the Average Rate of Return of 3D Printer = 4.5 %

Calculation of Average Rate of Return of Truck :

As per the information given in the question we have

Estimated total income over the useful life = $ 12,600

Useful Life = 7 years

Thus the Annual Net Income = Amount of investment / Useful Life

= $ 12,600 / 7 = $ 1,800

Amount of investment = $ 40,000

Estimated residual value = $ 0

We know that the Average Investment = ( Initial Investment + Residual value ) / 2

Applying the above information in the formula we have

= ( $ 40,000 + $ 0 ) / 2

= $ 40,000 / 2

= $ 20,000

Thus the Average Investment = $ 20,000

Applying the available information in the formula for Average Rate of return we have

= $ 1,800 / $ 20,000

= 0.09

= 9 %

Thus the Average Rate of Return of Truck = 9 %