Average Rate of Return—Cost Savings Master Fab Inc. is considering an investment

Question

Average Rate of Return—Cost Savings

Master Fab Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $137,000 with a $12,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $52,405 per year. In addition, the equipment will have operating and energy costs of $13,250 per year.

Determine the average rate of return on the equipment, giving effect to straight-line depreciation on the investment. If required, round to the nearest whole percent.
%

Explanation / Answer

Savings in wages               52405

less:energy cost                  (13250)

Less:depreciation               ( 25000)                                                       [(137000-12000)/ 5]

Net income                            14155

Rate of return = net income / Initial investment

                         = 14155 / 137000

                         = .1033 or 10.33% (approx 10%)

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