Question

Reynold company is considering an investment of $130,000 in new equipment. The new equipment is expected to last 5 years. It will have zero salvage value at the end of its useful life. Reynolds uses the straight-line method of depreciation for accounting purposes. The expected annual revenues and costs of the new product that will be product from the investment are:

Sales revenue $200,000

Less: Costs and Expenses 180,000

Income before income taxes $ 20,000

Income tax expense 7,000

Net Income $13,000

Computing Average Investment and Computing Expected Annual Rate of Return. Valor 20 points.

Average Investment = $65,000

Expected Annual rate of return= 20%

Average Investment = $60,000

Expected Annual rate of return= 18%

Average Investment = $85,000

Expected Annual rate of return= 30%

Average Investment = $75,000

Expected Annual rate of return= 40%

Answer 1

Solution:

Average investment = (Initial investment + Salvage value) / 2 = ($130,000 + 0) /2 = $65,000

Average annual income = $13,000

Expected annual rate of return = Average annual income /Average investment = $13,000 / $65,000 = 20%

Hence first option is correct.