Question

Denny Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art numerically controlled machine. The new machine would cost $190,000 and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new machine would cost $28,000 per year to operate and maintain, but would save $60,000 per year in labor and other costs. The old machine can be sold now for scrap for $19,000.

The simple rate of return on the new machine is closest to (Ignore income taxes.):

Answer 1

The simple rate of return is closest to 87.1%

Step-by-step explanation:

To calculate the rate of return, we will determine first determine the net return on investment on the machine after 10 years as follows:

cost of maintenance per year = $28,000

cost of maintenance for 10 years (expenditure) = 28,000 × 10 = $280,000

Labor savings per year = $60,000

Labor savings for 10 years ( income) = 60,000 × 10 = $600,000

Net income after 10 years = Total income - total expenditure

= 600,000 - 280,000 = $320,000

Next, we will determine the cost of investment as shown below:

cost of new machine = $190,000

scrap value of old machine = $19,000

Net cost of machine = 190,000 - 19,000 = $171,000

Therefore, the net return on investment is calculated as:

Net return on investment = Net income - cost of machine

= 320,000 - 171,000 = $149,000

Finally the rate of return in percentage, is calculated as follows:

rate of return = [(Net return on investment) ÷ (cost of investment) ] × 100

= ( 149,000 ÷ 171,000 ) × 100 = 87.1% (to 1 decimal place).