Question

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.

Answer 1

Answer:

23%

Explanation:

Cost of equipment = $132,000

Residual value = $16,000

Useful life = 10 years

Annual depreciation = (Cost of equipment - Residual value)/Useful life

= (132,000 - 16,000)/10

= $11,600

Annual saving in labor cost = $34,000

Increase in operating cost = $5,380

Annual saving in labor cost 34,000

Increase in operating cost -5,380

Annual depreciation -11,600

Net income $17,020

Average investment = (Cost of equipment + Salvage value)/2

= (132,000 + 16,000)/2

= $74,000

Average rate of return = Net income/Average investment

= 17,020/74,000

= 0.23% or 23%

Therefore the average rate of return on the equipment, giving effect to straight-line depreciation on the investment is 23%

Answer 2

Answer:

Midwest Fabric should go for equipment purchase.

Explanation:

The employee wage is $34,000 per year.

Let compare with the machine life span which is for 10 years.

Assume the employee will be paid $34,000 X 10 years as against use of machine, total expenses to be bared is =$340,000

The machine cost $132,000 which will have a residual value as at 10 years which is $16,000. Then we have to deduct that from the Original cost, to reflect the cost incurred. = $132,000 - $16,000 =$116,000.

The machine will require additional $5,380 per year for 10 years operation: $5,380 X 10years =$53,800.

Therefore, total expenses for the equipment is $116,000 + $53,800 = $164,000

My advice will be for the company to buy the machine as it will be less expensive to incur than the wages to be paid for the employee and it will also be more efficient in mode of operation than manual worker.