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 $142,000 with a $12,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $45,170 per year. In addition, the equipment will have operating and energy costs of $13,780 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 Check My Wor

Answer 1

Initial Investment = $142,000
Residual Value = $12,000
Useful Life = 5 years

Annual Depreciation = (Initial Investment - Residual Value) / Useful Life
Annual Depreciation = ($142,000 - $12,000) / 5
Annual Depreciation = $26,000

Annual Incremental Income = Cost Saving - Additional Cost
Annual Incremental Income = $45,170 - $13,780
Annual Incremental Income = $31,390

Average Investment = (Initial Investment + Residual Value) / 2
Average Investment = ($142,000 + $12,000) / 2
Average Investment = $77,000

Average Rate of Return = Annual Incremental Income / Average Investment
Average Rate of Return = $31,390 / $77,000
Average Rate of Return = 0.41 or 41%