Chapter 26, Problem 26.2EX

### Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

Chapter
Section

### Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

# Average rate of return—cost savingsMidwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $132,000 with a$16,000 residual value and a 10-year life. The equipment will replace one employee who has an average wage of $34,000 per year. In addition, the equipment will have operating and energy costs of$5,380 per year.Determine the average rate of return on the equipment, giving effect to straight-line depreciation on the investment.

To determine

Average rate of return method:

Average rate of return is the amount of income which is earned over the life of the investment. It is used to measure the average income as a percent of the average investment of the business, and it is also known as the accounting rate of return.

The average rate of return is computed as follows:

Average rate of return =Estimated average annual incomeAverage investment

To determine: The average rate of return on the equipment.

Explanation

Here, the equipment is replaced on the place of an employee who has an average wage of $34,000 per annum. In this case, the income from capital investment (equipment) is same as the average wage of that employee, thereby annual income from investment is$34,000. Depreciation and additional cost are expenses incurred during the year, and that should be deducted from the annual income from investment. Hence, estimated average income is $17,020, and average investment is$74,000...

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