Answer to Question #296808 in Financial Math for Brian

Question

A stone crushing company is planning to purchase a Wheel Loader to be used for conveying raw stone to a large Stone Crushing Machine and loading crushed stone in trucks. A new Wheel loader can be purchased directly from Caterpillar Company for $150,000. The new Wheel Loader will reduce the annual cost by $25,500 and increase annual operating expenses by $4,500. The useful life of the Wheel Loader is 20 years. After 20 years it will have a salvage value of $30,000. The company uses straight line method of depreciation for allassets

Present a case in support of the use of accounting rate of return as an investment appraisal technique

Answer 1

a). Step 1; Computation of depreciation:

Annual depreciation = (Cost of the asset – Salvage value)/Useful life

= ($150,000 – $30,000)/20

= $6,000

Step 2; Computation of annual net cost saving:

Annual net cost saving = $25,500 – ($4,500 + $6,000)

= $15,000

Step 3; Computation of average investment in asset:

Because the company uses straight line method of depreciation, the average investment can be computed by adding cost of the asset to the residual value and then dividing by 2. It is shown below:

Average investment = (Cost of the asset + Residual value)/2

= ($150,000 + $30,000)/2

= $90,000

Step 4; Computation of accounting rate of return:

Accounting rate of return = Annual net cost saving / average investment

= $15,000 / $90,000

= 16.67%