(Ignore income taxes in this problem.) Finlay Corporation is investigating automating a process by purchasing a machine for $225,000 that would have a 9 year useful life and no salvage value. By automating the process, the company would save $54,000 per year in cash operating costs. The new machine would replace some old equipment that would be sold for scrap now, yielding $24,000. The annual depreciation on the new machine would be $25,000. The simple rate of return on the investment is closest to:

Question

Quizplus · Accepted Answer

To calculate the simple rate of return, we need to divide the incremental annual net income by the initial investment.

Incremental annual net income = Savings in cash operating costs - Depreciation expense = $54,000 - $25,000 = $29,000

Initial investment = Cost of new machine - Salvage value + Gain on sale of old equipment = $225,000 - $0 + $24,000 = $249,000

Simple rate of return = Incremental annual net income ÷ Initial investment = $29,000 ÷ $249,000 = 0.1164 or 11.6%

Therefore, the closest option to the calculated simple rate of return is option D (14.5%). Thus, the company should not invest in this automation project because the simple rate of return is lower than their minimum required rate of return.

(Ignore Income Taxes in This Problem