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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.
Accounting (Text Only)
Solutions
Accounting (Text Only)
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.
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:
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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