Galactic Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 4,500 units at $212 per unit. The equipment has a cost of $418,500, residual value of $31,500, and an eight-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone follows: Cost per unit: Direct labor $36.00 Direct materials 140.00 Factory overhead (including depreciation) 24.00 Total cost per unit $200.00 Determine the average rate of return on the equipment. If required, round to the nearest whole percent. 18 %

24%

Explanation:

The computation of the average rate of return is shown below;

As we know that

The Average rate of return = Net income ÷ Average investment

where,

Net income is

= (Selling price per unit - totat cost per unit) × additional units sales

= ($212 - $200) × $4,500 units

= $54,000

And, the average investment is

= (cost price + equipment) ÷ 2

= ($418,500 + $31,500) ÷ 2

= $225,000

So, the average rate of return is

= $54,000 ÷ $225,000 × 100

= 24%

Galactic Inc.

Average Rate of Return: = Annual Net Income/Average Investment cost

= $54,000/$225,000 x 100

= 24%

Explanation:

Galactic Inc. Income Statement:

Sales Revenue, 4,500 x $212 = $954,000

Cost, 4,500 x $200 =                   900,000

Annual Net Income =                   $54,000

Average Investment in equipment = $225,000 ($418,500 + 31,500)/2

b) Galactic Inc.'s average rate of return (ARR) on the equipment is average (annual) net income that the equipment generates divided by the average cost of the investment, and then multiplied by 100.  The average cost of the investment equals the (initial book value + the residual value)/2.  The ARR also known as the Accounting Rate of Return does not take into consideration the time value of money.  As such, the net income is not discounted to the present value before the computation of the ratio.