Ray Zor Inc. is considering an investment in new equipment that will be used to manufacture a smartphone

Ray Zor Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 4,000 units at $410 per unit. The equipment has a cost of $525,000, residual value of $75,000, and an eight-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone is shown below.

Cost per unit:

Direct labor                                                  $ 30

Direct materials                                             280

Factory overhead (including depreciation)     40

Total cost per unit                                        $350

Determine the average rate of return on the equipment.

Answer:

Average Rate 

of Return  = 

= 

Average Annual Income 

Average Investment 

Average Revenues – Annual Product Costs* 

(Beginning Cost + Residual Value) ÷ 2 

($410 × 4,000 units) – ($350 × 4,000 units) 

= 

($525,000 + $75,000) ÷ 2 

= $240,000 

$300,000 

=  80% 

* The depreciation of the equipment is included in the factory overhead cost per unit.