Question

Lakeland Company is considering the purchase of equipment for $150,000. The equipment will expand the Company's production and increase revenue by $40,000 per year. Annual cash operating expenses will increase by $10,000. The equipment's useful life is 10 years with no salvage value. Lakeland uses straight-line depreciation. The income tax rate is 35%. What is the average rate of return on the investment?

a. Increase in revenue?
b. Increase in expenses?
c. Pretax income from investment?
d. Income tax expense?
e. Net income from investment?

Answer 1

13%

Step-by-step explanation:

The computation of the average rate of return on the investment is shown below:

= Annual net income ÷ average investment

The annual net income is shown below:

Increase in revenue $40,000

Less: Increase in expenses ($25,000)

Pretax income from investment $15,000

Less: Income tax expense $5,250 ($15,000 × 35%)

Net income from investment $9,750

The computation is shown below:

For increase in expense

= Annual cash operating expenses + Depreciation expense based on straight line method

= $10,000 + ($150,000 - $0 ÷ $10,000)

= $10,000 + $15,000

= $25,000

And, the average investment would be

= (Initial investment + salvage value) ÷ 2

= ($150,000 + $0) ÷ 2

= $150,000 ÷ 2

= $75,000

Now put these values to the above formula

So, the rate would equal to

= $9,750 ÷ $75,000

= 13%