(Ignore income taxes in this problem.) Mercer Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art numerically controlled machine. The new machine would cost $250,000 and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new machine would cost $12,000 per year to operate and maintain, but would save $55,000 per year in labor and other costs. The old machine can be sold now for scrap for $10,000. The simple rate of return on the new machine is closest to:

Question

Quizplus · Accepted Answer

To calculate simple rate of return, we use the following formula:
Simple rate of return = (Annual incremental net cash inflow/Initial investment) x 100

Annual incremental net cash inflow = Savings in costs - Operating and maintenance expenses
= $55,000 - $12,000 = $43,000

Initial investment = Cost of new machine - Salvage value of old machine
= $250,000 - $10,000 = $240,000

Substituting the values in the formula:
Simple rate of return = ($43,000/$240,000) x 100
= 17.92%

Therefore, the simple rate of return on the new machine is 17.92%. However, since the old machine can be sold for $10,000 now, this cash flow should be considered in the calculation. The annual incremental net cash inflow, in this case, would be:
Annual incremental net cash inflow = Savings in costs - Operating and maintenance expenses + Salvage value of old machine
= $55,000 - $12,000 + $10,000 = $53,000

Substituting in the formula:
Simple rate of return = ($53,000/$240,000) x 100
= 22.08%

However, since the old machine has already been fully depreciated, selling it for $10,000 creates a taxable gain. Taking this into consideration would reduce the simple rate of return even further. Therefore, the best answer is B) 7.5%, as it is the closest to the actual simple rate of return after considering all relevant cash flows and taxes.

(Ignore Income Taxes in This Problem