Question

The management of Ro Corporation is investigating automating a process. Old equipment, with a current salvage value of $27,000, would be replaced by a new machine. The new machine would be purchased for $432,000 and would have a 6 year useful life and no salvage value. By automating the process, the company would save $149,000 per year in cash operating costs. The simple rate of return on the investment is closest to (Ignore income taxes.):

Answer 1

Answer:

17.82%

Explanation:

As we know that:

Simple Rate Of Return = Net Operating Income / Initial Investment

Here

Initial Investment is $432,000

Net Operating Income = Annual Cost Savings - Annual Depreciation

Here

Annual Cost Savings are $149,000

Annual Depreciation =  $432,000/6 = $72,000

By putting values, we have:

Net Operating Income = $149,000 - $72,000 = $77,000

Now by putting values in the above bold equation:

Net Operating Income = $77,000 / 432,000 = 17.82%

Answer 2

Answer: 19.01%

Explanation:

The simple rate of return is the Income that came from an investment divided by the cost of the investment.

It is therefore expressed by;

Simple rate of return = Net Income / Initial investment

Initial investment

= Price of new machine - salvage value of old machine

= 432,000 - 27,000

= $405,000

Net Income

= Income - depreciation of new machine

= 149,000 - (432,000/6)

= $77,000

Simple rate of return

= 77,000/405,000

= 19.01%