The management of Ballard MicroBrew is considering the purchase of an automated bottling machine for $54,000. The machine would replace an old piece of equipment that costs $14,000 per year to operate.

The management of Ballard MicroBrew is considering the purchase of an automated bottling machine for $54,000. The machine would replace an old piece of equipment that costs $14,000 per year to operate. The new machine would cost $6,000 per year to operate. The old machine currently in use is fully depreciated and could be sold now for a salvage value of $20,000. The new machine would have a useful life of 10 years with no salvage value.

Required:

1. What is the annual depreciation expense associated with the new bottling machine?

2. What is the annual incremental net operating income provided by the new bottling machine?

3. What is the amount of the initial investment associated with this project that should be used for calculating the simple rate of return?

4. What is the simple rate of return on the new bottling machine? (Round your answer to 1 decimal place i.e. 0.123 should be considered as 12.3%.)

Explanation

1.

The annual depreciation expense is computed as follows:

Cost of the new machine (a)	$	54,000
Useful life in years (b)		10
Annual depreciation expense (a) ÷ (b)	$	5,400

2.

The annual incremental net operating income is computed as follows:

Operating cost of old machine	$	14,000
Less operating cost of new machine		6,000
Less annual depreciation on the new machine ($54,000 ÷ 10 years)		5,400
Annual incremental net operating income	$	2,600

3.

The initial investment is computed as follows:

Cost of the new machine	$	54,000
Less salvage value of old machine		20,000
Initial investment	$	34,000

4.

The simple rate of return is computed as follows:

Simple rate of return	=	Annual Incremental net operating income
		Initial investment
	=	$2,600	= 7.6%

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