A machine is purchased for an initial cost of 40000 The mach

A machine is purchased for an initial cost of $40,000. The machine has maintenance and operation costs of $2000 per year and generates $15,000 in revenue per year. The machine is expected to last for 3 years and have a salvage value of $5000. The rate of return is most nearly (rounded to nearest whole percentage): a. 7% b.3% Oc. d. e. None of these numerical values.

Solution

The real rate of return is most nearlt rounded to 3%.

Explaination : The real rate of return = Incremental operating income per year / initial cost

Incremental operating income = Revenue per year - ( maintenance and operational cost + Depreciation)

Here, Revenue per year = $15,000

Maintenance and operation cost = $2,000

Depreciation = ( Initial cost - Salvage value ) / Useful life of machine

Depreciation = ($40,000 - $5,000) / 3 = 40,000/3

put value in the formula of incremental operting income, we get

Incremental operating income = 15,000 - (2,000 + 40,000/3)

Incremental operating income = $4,000/3

Put this in real rate of return, we get

Real rate of return = (4,000/3) / 40,000

Solve this we get RRR = 4,000 / 120,000

RRR = 0.033 = 3.33%

means the nearest whole percentage is 3%

so correct ans is b) 3%