Question

Simple Rate of Return Method

The management of Stillford Micro Brew is considering the purchase of an automated bottling machine for $80,000. The machine would replace an old piece of equipment that costs $33,000 per year to operate. The new machine would cost $10,000 per year to operate. The old machine currently in use could be sold now for a scrap value of $5,000. The new machine would have a useful life of 10 years with no salvage value.

Required:

Compute the simple rate of return on the new automated bottling machine.

Answer 1

This is a cost reduction project so simple rate of return would be calculated as follows:
Operating cost of old machine	33,000
Less operating cost of new machine	(10,000)
Less annual depreciation on the new
machine ($80,000 ÷ 10 years)	(8,000)
Annual incremental net operating income	15,000
Cost of the new machine	80,000
Scrap value of old machine	(5,000)
Initial investment	75,000
Simple rate of return = Annual incremental net operating income ÷ Initial investment
Simple rate of return = 15000 ÷ 75000 = 20%