Average Rate of Return—New Product Pocket Pilot Inc. is considering an investmen

Question

Average Rate of Return—New Product Pocket Pilot Inc. is considering an investment in new equipment that will be used to manufacture a mobile communications device. The device is expected to generate additional annual sales of 3,600 units at $284.00 per unit. The equipment has a cost of $401,800, residual value of $30,200, and an eight-year life. The equipment can only be used to manufacture the device. The cost to manufacture the device is shown below.

Cost per unit: Direct labor $47.00

Direct materials 182.00

Factory overhead (including depreciation) 31.60

Total cost per unit $260.60

Determine the average rate of return on the equipment. If required, round to the nearest whole percent.

Explanation / Answer

Profit = unit sold (selling price -cost)

         = 3600 (284 - 260.6 )

        = 3600 * 23.4

       = 84240

Total profit for 8 years = 84240 * 8 = 673920

Average profit = (673920 + 30200) / 8

                          = 704120/ 8

                          = 88015

Average rate of return =Average profit /Investment

                                     = 88015 / 401800

                                    = .2191 or 21.91%   (approx 22%)

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