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Average rate of return—cost savings Midwest 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.

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Accounting (Text Only)

26th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781285743615

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Section
BuyFindarrow_forward

Accounting (Text Only)

26th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781285743615
Chapter 26, Problem 26.2EX
Textbook Problem
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Average rate of return—cost savings

Midwest 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 of Solution

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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Chapter 26 Solutions

Accounting (Text Only)
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