Simple Rate of Return Method The management of Stillford Micro Brew is consideri

Question

Simple Rate of Return Method

The management of Stillford Micro Brew is considering the purchase of an automated bottling machine for $80,000. The machine would replace an old piece of equipment that costs $33,000 per year to operate. The new machine would cost $10,000 per year to operate. The old machine currently in use could be sold now for a scrap value of $5,000. The new machine would have a useful life of 10 years with no salvage value.

Required:

Compute the simple rate of return on the new automated bottling machine.

Explanation / Answer

This is a cost reduction project so simple rate of return would be calculated as follows: Operating cost of old machine           33,000 Less operating cost of new machine         (10,000) Less annual depreciation on the new machine ($80,000 ÷ 10 years)           (8,000) Annual incremental net operating income           15,000 Cost of the new machine           80,000 Scrap value of old machine           (5,000) Initial investment           75,000 Simple rate of return = Annual incremental net operating income ÷ Initial investment Simple rate of return = 15000 ÷ 75000 = 20%

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