Round rates to six decimal points — Barlae Auto Repair Inc evaluating project purchase equipment that will not only — uses the unadjusted rate return use average investment

Barlae Auto Repair, Inc. is evaluating a project to purchase equipment that will not only expand the company’s capacity but also improve the quality of its repair services. The board of directors requires all capital investments to meet or exceed the minimum requirement of a 10 percent rate of return. However, the board has not clearly defined the rate of return. The president and controller are pondering two different rates of return: unadjusted rate of return and internal rate of return. The equipment, which costs $200,000, has a life expectancy of five years. The increased net profit per year will be approximately $14,000, and the increased cash inflow per year will be approximately $55,400.

Required

Round rates to six decimal points.

a. If it uses the unadjusted rate of return (use average investment) to evaluate this project, should the company invest in the equipment?

b. If it uses the internal rate of return to evaluate this project, should the company invest in the equipment?

c. Which method is better for this capital investment decision?

SOLUTION

a. Unadjusted Rate of Return:

Average increase in net income Average net cost of original investment