A company is considering purchasing factory equipment that costs $320,000 and is estimated to have no salvage value at the end of its 8-year useful life. If the equipment is purchased, annual revenues are expected to be $90,000 and annual operating expenses exclusive of depreciation expense are expected to be $38,000. The straight-line method of depreciation would be used.
If the equipment is purchased, the annual rate of return expected on this equipment is
A) 32.5%.
B) 3.8%.
C) 7.5%.
D) 16.3%.

Question

Quizplus · Accepted Answer

First, we need to calculate the annual depreciation expense using the straight-line method:
Depreciation expense = (Purchase price - Salvage value) / Useful life
Depreciation expense = ($320,000 - $0) / 8 years
Depreciation expense = $40,000 per year

Next, we can calculate the annual net income:
Net income = Revenues - Operating expenses - Depreciation expense
Net income = $90,000 - $38,000 - $40,000
Net income = $12,000 per year

Finally, we can use the following formula to calculate the annual rate of return:
Annual rate of return = (Annual net income / Purchase price) x 100%
Annual rate of return = ($12,000 / $320,000) x 100%
Annual rate of return = 3.75%

Therefore, the expected annual rate of return on this equipment is 3.75%, which is closest to answer choice C (7.5%). This suggests that purchasing the equipment may not be a financially sound decision.

A Company Is Considering Purchasing Factory Equipment That Costs $320,000