Question

Average Rate of Return

Lakeland Company is considering the purchase of equipment for $175,000. The equipment will expand the Company's production and increase revenue by $40,000 per year. Annual cash operating expenses will increase by $12,000. The equipment's useful life is 10 years with no salvage value. Lakeland uses straight-line depreciation. The income tax rate is 25%. What is the average rate of return on the investment?

Round answer to the nearest whole percentage, if applicable.

Average rate of return on investment %? I have the answer as .045 which would round to 5% but the answer keeps getting marked as incorrect.

Answer 1

In order to calculate the average rate of return on investment, we use the following formula:-

Average Rate of return = Annual Net Income/Average Investment * 100

Average Investment = ($175,000 + $0)/2

Average Investment = $87,500

Calculation of Net income is calculated as follows:-

Particulars	Amount
Incremental Revenue	40,000
Less:- Operating expenses	(12,000)
Less:- Depreciation ($175,000/10 years)	(17,500)
Income before taxes	10,500
Less:- Income tax (25% * $10,500)	(2,625)
Net Income	7,875

Average Rate of Return = $7,875/$87,500

Average Rate of Return = 9%

Based on the calculation above, the average rate of return is 9%.

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