To determine the project's accounting rate of return (ARR), we need to calculate the average annual net operating income over the useful life of the automation equipment and then divide it by the initial investment.
Step 1: Calculate the annual net operating income.
Net operating income is the total revenue minus total variable costs and fixed manufacturing costs.
For the current (no automation) scenario:
Contribution margin per unit = Sales revenue per unit - Total variable manufacturing costs per unit
Contribution margin per unit = $94 - $45 = $49
Contribution margin (per unit) x Sales volume = Total contribution margin
$49 x 89,000 units = $4,361,000
Net operating income = Total contribution margin - Fixed manufacturing costs
Net operating income = $4,361,000 - $1,120,000 = $3,241,000
For the proposed (automation) scenario:
Contribution margin (per unit) x Sales volume = Total contribution margin
$49 x 135,000 units = $6,615,000
Net operating income = Total contribution margin - Fixed manufacturing costs
Net operating income = $6,615,000 - $2,250,000 = $4,365,000
Step 2: Calculate the average annual net operating income.
Average annual net operating income = (Net operating income current + Net operating income proposed) / 2
Average annual net operating income = ($3,241,000 + $4,365,000) / 2 = $3,803,000
Step 3: Calculate the initial investment.
The initial investment in automation is $8.16 million.
Step 4: Calculate the accounting rate of return (ARR).
ARR = (Average annual net operating income / Initial investment) x 100
ARR = ($3,803,000 / $8,160,000) x 100 ≈ 46.63%
The accounting rate of return for the automation project is approximately 46.63%.