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 is fully depreciated and 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. What is the annual depreciation expense associated with the new bottling machine?

Depreciation = (Cost of the Machine - salvage value ) / Life = ( 54000 - 0 ) / 10 = 5400

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

Savings in Operating cost
Operating cost with old Machine	14000
(-) Operating cost with new machine	6000
Annual savings	8000
(-) Additional depreciation
= 5400 - 0	5400
Net Operating Income	2600

3. What is the amount of the initial investment

Cost of new machine	54000
(-) Sale of old machine	20000
Net Initial Investment	34000

4. What is the simple rate of return on the new bottling machine?

Simple rate of return = 2600 / 34000 * 100 = 7.65%