Question

Compute unadjusted rate of return for a new machine (L.O. 4) Jefferson Company is considering investing $33,000 in a new machine. The machine is expected to last five years and to have a salvage value of $8,000. Annual before-tax net cash inflow from the machine is expected to be $7,000. The income tax rate is 40%.

Answer 1

3.64%

Step-by-step explanation:

Annual depreciation expenses = (Cost of new machine - Salvage value)/Expected useful life = ($33,000 - $8,000) ÷ 5 = $25,000 ÷ 5 = $5,000

Annual net income = (Annual before tax net cash inflow - Annual depreciation expenses) × (1 - Income Tax Rate) = ($7,000 - $5,000) × (1 - 40%) = ($2,000) × (0.60) = $1,200

Since unadjusted rate of return does not take into account the time value of money, it can therefore before computed as follows:

Unadjusted rate of return = Annual net Income ÷ Cost of new machine = $1,200 ÷ $33,000 = 0.0364, or 3.64%