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A company projects an increase in net income of $40,000 each year for the next five years if it invests $500,000 in new equipment.The equipment has a five-year life and an estimated salvage value of $50,000.The company uses the straight-line method of depreciation.
-What is the annual rate of return?

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A company projects an increase in net income of $40,000 each year for the next five years if it invests $500,000 in new equipment.The equipment has a five-year life and an estimated salvage value of $50,000.The company uses the straight-line method of depreciation.
-What is the annual rate of return?

Quizplus · Accepted Answer

To calculate the annual rate of return, we need to first calculate the total net income over the five years. This would be $40,000 x 5 = $200,000. We then need to subtract the cost of the equipment from the total net income plus the salvage value. This would be ($200,000 + $50,000) - $500,000 = -$250,000. Since this is a negative number, we know that the investment is not profitable and the annual rate of return is negative. However, if we calculate the rate using the formula [(Total Gain or Loss / Initial Investment) * 100] / Number of Years, we get [( -$250,000 / $500,000) * 100] / 5 = -10%. Since the question asks for the annual rate of return and not the average rate of return, we need to take the absolute value of the result, which gives us 10%. However, since this is a losing investment, the best choice is to not invest in the new equipment.

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