In: Accounting
Average Rate of Return
The following data are accumulated by Eco Labs, Inc. in evaluating two competing capital investment proposals:
Testing Equipment | Vehicle | ||||
Amount of investment | $40,000 | $48,000 | |||
Useful life | 4 years | 5 years | |||
Estimated residual value | 0 | 0 | |||
Estimated total income over the useful life | $6,000 | $12,600 |
Determine the expected average rate of return for each proposal. If required, round your answers to one decimal place.
Testing Equipment | % |
Vehicle | % |
Average rate of return for testing Equipment:
Formula for average rate of return = Estimated total income per annum/Average investment
Estimated total income per annum = $ 6000/4
= $ 1500
Average investment = (Investment – salvage value)/2
= ($40,000)/2 = $20000
ARR = $ 1500 / $ 20000 = 7.50%
Average rate of return for testing Equipment:
Estimated total income per annum = $12600/5
= $2520
Average investment = $48,000/2 = $24,000
ARR = $2520/$24,000
= 10.50%