Beacon company is considering automating its production facility. the initial investment in automation would be $15 million, and the equipment has a useful life of 10 years with a residual value of $500,000. the company will use straight-line depreciation. beacon could expect a production increase of 40,000 units per year and a reduction of 20 percent in the labor cost per unit. determine the project's accounting rate of return

Additional Information:

Net Operating Income before investment $1,710,000

Net Operating Income After investment $2,690,000

Answer:

12.65%

Explanation:

Now the project's accounting rate of return can be calculated using the following formula:

Accounting rate of return = Average Project Net Income / Avg. Investment

Here

Average Project Net Income is $980,000 per year (Step1)

and

Average investment is $7,750,000 (Step2)

By putting values, we have:

Accounting rate of return = $980,000 / $7,750,000 = 12.65%

Step1: Average Project Net Income

The relevant cash generated due to additional sales is the difference of the net operating income before investment and after investment, which is:

Investment Profit per year = $2,690,000 - $1,710,000 = $980,000 per year

Step2: Average Investment

Average Investment = (Initial Investment + Residual Value) / 2

Here

Initial Investment is $15 million

and

Residual Value is $0.5 million

So by putting values, we have:

Average Investment = ($15 million + $0.5 Million) / 2 = $7.75 million