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 $105,000 with a $9,000 residual value and a five-year life. The equipment will replace one employee who has an average wage of $32,230 per year. In addition, the equipment will have operating and energy costs of $10,180 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

Calculate average rate of return :

Straight line dep = (105000-9000/5) = 19200

Annual cost saving = (32230-10180-19200) = 2850

Average investment = (105000+9000/2) = 57000

Average rate of return = annual cost saving*100/average investment

= 2850*100/57000

Average rate of return = 5%

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