Question

A company is considering purchasing factory equipment that costs $340,000 and is estimated to have a $20,000 salvage value at the end of its 8-year useful life. If the equipment is purchased, annual revenues are expected to be $90,000 and annual operating expenses including depreciation expense are expected to be $78,000. The straight-line method of depreciation would be used. If the equipment is purchased, the annual rate of return (rounded) on this equipment is Group of answer choices 7.1% 6.7% 7.5% 3.5%

Answer 1

Cost of equipment = $340,000

Salvage value = $20,000

Estimated life = 8 years

Annual depreciation expense = ($340,000 - $20,000)/8 = $40,000

Annual revenues = $90,000

Annual operating expense including depreciation = $78,000

Annual operating expenses excluding depreciation = $78,000 - $40,000 = $38,000

Annual net profit = Annual Revenues – Operating expenses – Depreciation

                           = $90,000 - $78,000 = $12,000

Annual rate of return = Annual net profit/Initial investment

= $12,000/$340,000 * 100

0.03529 or 3.5%

So, correct answer is 3.5%