Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $132,000

Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor. The equipment has a cost of $132,000 with a $16,000 residual value and a 10-year

life. The equipment will replace one employee who has an average wage of $34,000 per year. In addition, the equipment will have operating and energy costs of $5,380 per year.

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

Answer:

Average Rate 

of Return   =

 

= 

Average Annual Income 

Average Investment 

 

Average Savings* – Annual Depreciation – Additional Operating Costs 

(Beginning Cost + Residual Value) ÷ 2 

$34,000 – [($132,000 – $16,000) ÷ 10 years] – $5,380 

= 

($132,000 + $16,000) ÷ 2 

= $17,020 

$74,000 

=  23% 

* The effect of the savings in wages expense is an increase in income.