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Average Rate of Return—Cost Savings Midwest Fabricators Inc
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. If required, round to the nearest whole percent.
%
Expert Solution
Computation of the average rate of return on the investment:-
Depreciation expense = (Cost - Salvage value) / Estimated useful life
= ($132,000 - $16,000) / 10
= $116,000 / 10
= $11,600
Average annual income = Average savings - Depreciation expense - Operating & energy costs
= $34,000 - $11,600 - $5,380
= $17,020
Average investment = ($132,000 + $16,000) / 2
= $148,000 / 2
= $74,000
Average rate of return = Average annual income / Average investment
= $17,020 / $74,000
= 23%
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