Question

# Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment...

Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of \$141,000 with a \$12,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of \$47,120 per year. In addition, the equipment will have operating and energy costs of \$13,670 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. %

Solution:

Initial Investment in Equipment = \$141,000

Residual value = \$12,000

Annual Depreciation = (\$141,000 - \$12,000) / 5 = \$25,800

Annual Increase in Income (Annual Earnings) = Saving of Direct Labor Wages - Annual Operating and energy costs - Annual Depreciation

= \$47120 - \$13670 - \$25800 = \$7,650

Average Investment = (Initial Investment +Residual value)/2 = (\$141000+\$12000) /2 = \$76,500

Average rate of Return = Annual Earnings / average Investment = \$7650 / \$76500 = 10%

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