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Beacon Company is considering automating its production facility. The initial investment in automation would be $8.16
million, and the equipment has a useful life of 7 years with a residual value of $1,020,000. The company will use straight-
line depreciation. Beacon could expect a production increase of 46,000 units per year and a reduction of 20 percent in
the labor cost per unit.
Production and sales volume
Sales revenue
Variable costs
Direct materials
Direct labor
Variable manufacturing overhead
Total variable manufacturing costs
Contribution margin
Fixed manufacturing costs
Net operating income
Required:
2. Determine the project's accounting rate of return.
Mana Pa dalmat---
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7
Current (no automation) 89,000 Proposed (automation) 135,000
units
units
Per Unit
$94
$ 19
25
10
54
$ 40
10
of 15
Total
$?
?
1,120,000
?
Per Unit
$94
Next >
$ 19
?
10
?
$ 45
Total
$?
?
2,250,000
?

Answer 1

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%.