Midwest Fabricators Inc. is considering an investment in equipment that will rep
ID: 2414333 • Letter: M
Question
Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $111,000 with a $10,000 residual value and a ten-year life. The equipment will replace one employee who has an average wage of $19,080 per year. In addition, the equipment will have operating and energy costs of $5,350 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.
Explanation / Answer
Computation of average rate of return on the equipment :
Average annual net savings = Annual savings - Annual Estimated Cash cost
Annual savings = Savings in average wages = 19080
Annual depreciation = (Cost of equipment - Scrap value)/Useful life
= (111000 - 10000)/10 = 10100
Annual estimated cash costs = operating and energy costs = 5350
Average annual net savings = 19080 - 5350 - 10100 + 10100 = 13730
Average investment = (Opening investment + Scrap value) / 2
= (111000 + 10000) / 2 = 60500
Average Rate of Return = Average annual net savings / Average Investment
=13730 / 60500 = 22.69%
Note: Depreciation is non cash expenditure and it will not have any effect on cash savings per year.