Question

Average Rate of Return—New Product Galactic Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 6,500 units at $269 per unit. The equipment has a cost of $604,500, residual value of $45,500, and an eight-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone follows: Cost per unit: Direct labor $45.00 Direct materials 175.00 Factory overhead (including depreciation) 30.50 Total cost per unit $250.50 Determine the average rate of return on the equipment. If required, round to the nearest whole percent. %

Answer 1

Average rate of return=Avergae income/Avergae investment

Average income= Average Operating profit

Average operating profit=( Sales-total cost per unit)

Sales= Units sold*Sales price per unit

Sales= 6,500*$269= $1,748,500

Total cost of additional revenue= Total cost per unit*unit sold

=250.5*6,500= $ 1,628,250

Average operating profit= $1,748,500-$1,628,250

Average operating profit=$ 120,250

Average investment=( Book value of investment in the begining+Book value of investment at the end)/2   

Book value of investment in the begining=$604,500

Book value of investment at the end=$45,500

Average investment=(605,500+45,500)/2

=651,000/2

Average investment=$325,500

Average Rate of return= 120,250/325,500

=36.94%

Average Rate of return= 37% (Rounded )

Note-1

Here we have considered depriciation in calculating average rate of return and it is based on account profits and not cash flow, so depreiciation is considered.

Note-2

Since no information about tax is given we have used operating profit, in case information about tax would have been given we would have use after tax profits.

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