A company is considering purchasing factory equipment that costs $400,000 and is estimated to have no salvage value at the end of its 5-year useful life.If the equipment is purchased, annual revenues are expected to be $150,000 and annual operating expenses exclusive of depreciation expense are expected to be $25,000.The straight-line method of depreciation would be used.If the equipment is purchased, the annual rate of return expected on this equipment is

Question

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The annual net income (revenue - operating expenses exclusive of depreciation expense) would be $125,000 ($150,000 - $25,000). The annual depreciation expense would be $80,000 ($400,000 / 5 years). Therefore, the annual cash inflow (net income + depreciation expense) would be $205,000 ($125,000 + $80,000).
The initial investment is $400,000.
Using the formula for annual rate of return, we get:
Annual rate of return = ((Total cash inflow - initial investment) / initial investment) × 100%
= (($205,000 × 5) - $400,000) / $400,000 × 100%
= 31.25%
Therefore, the expected annual rate of return on this equipment is 31.25%, which is option B.

A Company Is Considering Purchasing Factory Equipment That Costs $400,000