Question

Sager Industries is considering an investment in equipment that will replace direct labor. The equipment has a cost of $1,200,000 with a $300,000 residual value and a 10-year life. The equipment will replace three employees who has an average total wages of $180,000 per year. In addition, the equipment will have operating and energy costs of $7,500 per year.

Determine the average rate of return on the equipment, giving effect to straight-line depreciation on the investment.

Answer 1

Average rate of return = 11%

Step-by-step explanation:

Depreciation = (Cost of equipment - Residual value) / Useful years

Depreciation = (1,200,000-300,000) / 10

Depreciation = 90,000

Increase in net annual income = 180,000 - 90,000 - 7,500

Increase in net annual income = 82,500

Average investment = (1,200,000 + 300,000) / 2 = 750,000

Average rate of return = Increase in net annual income / Average investment

Average rate of return = 82,500/750,000

Average rate of return = 0.11

Average rate of return = 11%