Midwest Fabricators Inc. is considering an investment in equipment that will rep
ID: 2536557 • Letter: M
Question
Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $131,000 with a $11,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $50,210 per year. In addition, the equipment will have operating and energy costs of $12,720 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
Annual Depreciation = ($131,000 - $11,000) / 5 = $24,000
Annual Net Income would increase = $50,210 - $12,720 - $24,000 = $13,490
Average Investment = ($131,000 + $11,000) / 2 = $71,000
Average rate of return = Annual Net Income would increase / Average Investment
Average rate of return = $13,490 / $71,000 = 19%