Question

Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $92,000 with a $8,000 residual value and a ten-year life. The equipment will replace one employee who has an average wage of $16,850 per year. In addition, the equipment will have operating and energy costs of $4,450 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. %

Answer 1

Cost of Equipment = $92,000
Residual Value = $8,000
Useful Life = 10 years

Annual Depreciation = (Cost of Equipment - Residual Value) / Useful Life
Annual Depreciation = ($92,000 - $8,000) / 10
Annual Depreciation = $8,400

Cost Saving = $16,850
Operating and Energy Costs = $4,450

Annual Profit = Cost Saving - Operating and Energy Costs – Depreciation
Annual Profit = $16,850 - $4,450 - $8,400
Annual Profit = $4,000

Average Investment = (Cost of Equipment + Residual Value) / 2
Average Investment = ($92,000 + $8,000) / 2
Average Investment = $50,000

Average Rate of Return = Annual Profit / Average Investment
Average Rate of Return = $4,000 / $50,000
Average Rate of Return = 8.00%