Question

The CFO of The Fun Factory is investigating the possibility of investing in a three dimensional printer that would cost $20,000. The printer would eliminate the need to have prototypes of new toys be produced by a third party. The cost of having the prototypes manufactured by the third party is about $8,000 per year. The printer would have a useful life of five years with no salvage value with expected annual operating costs of $3,000 per year.

 

Required:

Compute the simple rate of return on the printer.

Answer 1

The annual incremental operating income is determined by comparing the costs of outsourcing the production of toy prototypes to the operating cost of the new printer and the depreciation that would be taken on the new printer:

 

Annual cost of outsourcing prototypes.....................................................$8,000

Less: annual operating cost of new printer..............................................(3,000)

Less: annual depreciation on the new machine

       ($20,000 ÷ 5 years)...................................................................................(4,000)

Annual incremental operating income.....................................................$1,000

 

Initial investment..............................................................................................$20,000

 

The simple rate of return is $4,000 ÷ $20,000 = 5%.

The simple rate of return is 5%.