Question

The management of Ballard MicroBrew is considering the purchase of an automated bottling machine for $54,000. The machine would replace an old piece of equipment that costs $14,000 per year to operate. The new machine would cost $6,000 per year to operate. The old machine currently in use could be sold now for a salvage value of $20,000. The new machine would have a useful life of 10 years with no salvage value.

Required:

1. What is the annual depreciation expense associated with the new bottling machine?

2. What is the annual incremental net operating income provided by the new bottling machine?

3. What is the amount of the initial investment associated with this project that should be used for calculating the simple rate of return?

4. What is the simple rate of return on the new bottling machine? (Round your answer to 1 decimal place i.e. 0.123 should be considered as 12.3%.)

Answer 1

1) Annual depreciation expense =$54,000/10 Annual depreciation expense =$5,400 2) Annual incremental net operating income = Operating costs of old machine-Operating costs of new machine-Annual depreciation Annual incremental net operating income = $14,000 - $6,000 - $5,400 Annual incremental net operating income = $2,600 3) Amount of initial investment = Cost of new machine - Salvage value of old machine Amount of initial investment = $54,000 - $20,000 Amount of initial investment = $34,000 4) Simple rate of return = Annual incremental net operating income/Initial investment Simple rate of return = $2,600/$34,000 Simple rate of return = 7.6%