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 $90,000 with a $8,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $31,460 per year. In addition, the equipment will have operating and energy costs of $8,690 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.
ARR is 7% or 13%
As there is two formula to calculate ARR ie from Initial Investment and Average investment .
Average rate of Return is the return on Net income to the average investment or intial investment . It is return generated from the capital investment.
Depreciation on Investment under Straight-line
Depreciation =(Cost of Equipment - Salvage value )/ Useful life of Asset
Net Increase in profit /Income from saving in labour cost .
|Net Income per annum|
|Saving in Labour cost||$31460|
|less : Annual incremental cost on Equipment||$(8690)|
|Less :Annual Depreciation||$(16400)|
|Net Saving /Income||$6370|
Average Annual Rate of Return =Net income /Intial Investment or Average investment
Or Average Investment = (Cost of Equipment + Salvage)/2
Average Annual Return =6370/49000 = 13%
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