Question

# Average Rate of Return—Cost Savings Midwest Fabricators Inc. is considering an investment in equipment that will...

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

=(90000-8000)/5

=82000/5

=16400

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

=\$6370/90000

=7%

Or Average Investment = (Cost of Equipment + Salvage)/2

=(90000+8000)/2

=49000

Average Annual Return =6370/49000 = 13%

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