Question

Average Rate of Return—Cost Savings

Maui Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $124,000 with a $11,000 residual value and a ten-year life. The equipment will replace one employee who has an average wage of $24,040 per year. In addition, the equipment will have operating and energy costs of $5,990 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

Answer:

Determination of Average rate of return:

Average rate of return = Average annual net income* / Average investment**

= $6,750 / $67,500

= 10%

Accordingly, average rate of return on the equipment is 10%.

Note:

*Calculation of average annual net income:

Particulars	Amount
Saving in employees cost	$24,040
(-) Operating & energy cost of equipment	($5990)
(-) Depreciation	($11,300)
Net Income	$6,750

Depreciation = (Cost of equipment - Residual Value) / Useful life

= $124,000- $11,000) / 10 years

= $11,300

Note:

**Calculation of average Investment:

Average investment = (Cost of equipment + Residual Value) /2

= ($124,000 + $11,000) /2

= $67,500