Question

Average Rate of Return—Cost Savings

Sager Industries is considering an investment in equipment that will replace direct labor. The equipment has a cost of $127,000 with a $11,000 residual value and a 10-year life. The equipment will replace three employees who has an average total wages of $23,270 per year. In addition, the equipment will have operating and energy costs of $6,150 per year.

Determine the average rate of return on the equipment, giving effect to straight-line depreciation on the investment.
%

Answer 1

Answer:
Straight line depreciation per year = (Cost – Salvage Value) / Useful Life
Straight line depreciation per year = (127,000 – 11,000) / 10
Straight line depreciation per year = 116,000 / 10
Straight line depreciation per year = $11,600

Average Rate of Return = Annual Income / Average Investment * 100

Annual Income = Cost Saving – Expenses
Annual Income = $23,270 – ($6,150 + $11,600)
Annual Income = $5,520

Average Investment = (127,000 + 11,000) / 2
Average Investment = $69,000

Average Rate of Return = 5,520 / 69,000 * 100
Average Rate of Return = 8.00%