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?

Question

Quizplus · Accepted Answer

The annual rate of return can be calculated by finding the average annual income and dividing it by the average investment. The average annual income is the net income increase of $40,000 minus the annual depreciation. The annual depreciation is ($500,000 - $50,000) / 5 = $90,000. So, the average annual income is $40,000 - $90,000 = -$50,000 (this seems to be a mistake in calculation, as the correct approach should consider the net income increase without subtracting depreciation, since depreciation is a non-cash expense that has already been accounted for in determining the net income increase). The correct average annual income should be $40,000. The average investment is the midpoint between the initial investment and the salvage value, which is ($500,000 + $50,000) / 2 = $275,000. The annual rate of return is ($40,000 / $275,000) * 100 = 14.5%.

A Company Projects an Increase in Net Income of $40,000