Midwest Fabricators Inc. is considering an investment in equipment that will replace direct labor

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.