question archive Simple Rate of Return Method The management of Stillford Micro Brew is considering the purchase of an automated bottling machine for $80,000
Simple Rate of Return Method The management of Stillford Micro Brew is considering the purchase of an automated bottling machine for $80,000
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Simple Rate of Return Method
The management of Stillford Micro Brew is considering the purchase of an automated bottling machine for $80,000. The machine would replace an old piece of equipment that costs $33,000 per year to operate. The new machine would cost $10,000 per year to operate. The old machine currently in use could be sold now for a scrap value of $5,000. The new machine would have a useful life of 10 years with no salvage value.
Required:
Compute the simple rate of return on the new automated bottling machine.
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Answer:
| This is a cost reduction project so simple rate of return would be calculated as follows: | |||||
| Operating cost of old machine | 33,000 | ||||
| Less operating cost of new machine | (10,000) | ||||
| Less annual depreciation on the new | |||||
| machine ($80,000 ÷ 10 years) | (8,000) | ||||
| Annual incremental net operating income | 15,000 | ||||
| Cost of the new machine | 80,000 | ||||
| Scrap value of old machine | (5,000) | ||||
| Initial investment | 75,000 | ||||
| Simple rate of return = Annual incremental net operating income ÷ Initial investment | |||||
| Simple rate of return = 15000 ÷ 75000 = 20% | |||||
