Question

verage Rate of Return
Lakeland Company is considering the purchase of equipment for $140,000. The equipment will expand the Company's production and increase revenue by $35,000 per year. Annual cash operating expenses will increase by $10,000. The equipment's useful life is 10 years with no salvage value. Lakeland uses straight-line depreciation. The income tax rate is 35%. What is the average rate of return on the investment?

Do not use negative signs with your answers.

Increase in revenue	Answer
Increase in expenses	Answer
Pretax income from investment	Answer
Income tax expense	Answer
Net income from investment	Answer

Answer 1

Increase in revenue	$35000
Increase in expenses	(10000)
Pretax income from investment	25000
Income tax expense (25000*35%)	(8750)
Net income from investment	$16,250

Average rate of return on the investment  = Net income from investment / Initial investment

= 16250 / 140000

= 11.61%

Answer 2

Compute the average rate of return as follows: Average rate of return = Average annual incremantal income Average investment $7,150 $140,000+$0 = 9.53% Compute the net income from investment as follows: Amount (S) $35,000 $24,000 Particulars Increase in revenue Increase in expenses (Depreciation exp. + Cash operating exp.) [($140,000-$0-10 years]+($10,000) Pretax income from investment Income tax expense ($11,000 x 35%) Net income from investment $11,000 $3,850 $7,150