Midwest Fabricators Inc. is considering an investment in equipment that will rep
ID: 2526421 • Letter: M
Question
Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $80,000 with a $7,000 residual value and a ten-year life. The equipment will replace one employee who has an average wage of $15,955 per year. In addition, the equipment will have operating and energy costs of $3,870 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
Solution:
Cost of equipment = $80,000
Residual value = $7,000
Life = 10 years
Annual depreciation - SLM = (Cost - Residual Value) / Life of asset = ($80,000 - $7,000) /10 = $7,300
Annual savings = $15,955 - $3,870 = $12,085
Net annual increase in income = Annual savings - depreciation on equipment = $12,085 - $7,300 = $4,785
Average investment = (Cost + Salvage value) / 2 = ($80,000 + $7,000)/2 = $43,500
Average rate of return on equipment = Average income from equipment / Average investment
= $4,785 / $43,500 = 11%