(Ignore income taxes in this problem.) The management of Stanforth Corporation is investigating automating a process. Old equipment, with a current salvage value of $24,000, would be replaced by a new machine. The new machine would be purchased for $516,000 and would have a 6 year useful life and no salvage value. By automating the process, the company would save $173,000 per year in cash operating costs. The simple rate of return on the investment is closest to:

Question

Quizplus · Accepted Answer

The simple rate of return is calculated as the annual incremental net operating income divided by the initial investment. The annual savings is $173,000, and the initial investment is $516,000 - $24,000 (salvage value of old equipment), which equals $492,000. The simple rate of return is $173,000 / $492,000 = 0.3512 or 35.12%. However, since the machine has no salvage value, the depreciation expense is $516,000 / 6 = $86,000 per year. The annual incremental net operating income is $173,000 - $86,000 = $87,000. Therefore, the simple rate of return is $87,000 / $492,000 = 0.1768 or 17.68%, which is closest to 17.7%.

(Ignore Income Taxes in This Problem