Question

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. %

Answer 1

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%