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29 February, 10:29

Denny Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art numerically controlled machine. The new machine would cost $190,000 and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new machine would cost $28,000 per year to operate and maintain, but would save $60,000 per year in labor and other costs. The old machine can be sold now for scrap for $19,000.

The simple rate of return on the new machine is closest to (Ignore income taxes.) :

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  1. 29 February, 11:17
    0
    The simple rate of return is closest to 87.1%

    Explanation:

    To calculate the rate of return, we will determine first determine the net return on investment on the machine after 10 years as follows:

    cost of maintenance per year = $28,000

    cost of maintenance for 10 years (expenditure) = 28,000 * 10 = $280,000

    Labor savings per year = $60,000

    Labor savings for 10 years (income) = 60,000 * 10 = $600,000

    Net income after 10 years = Total income - total expenditure

    = 600,000 - 280,000 = $320,000

    Next, we will determine the cost of investment as shown below:

    cost of new machine = $190,000

    scrap value of old machine = $19,000

    Net cost of machine = 190,000 - 19,000 = $171,000

    Therefore, the net return on investment is calculated as:

    Net return on investment = Net income - cost of machine

    = 320,000 - 171,000 = $149,000

    Finally the rate of return in percentage, is calculated as follows:

    rate of return = [ (Net return on investment) : (cost of investment) ] * 100

    = (149,000 : 171,000) * 100 = 87.1% (to 1 decimal place).
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