Pierre's Hair Salon is considering opening a new location in French Lick, California. The cost of building a new salon is $286,000. A new salon will normally generate annual revenues of $68,500, with annual expenses (including depreciation) of $41,200. At the end of 15 years the salon will have a salvage value of $78,000. Calculate the annual rate of return on the project. Annual rate of return __ %.

Annual rate of return of building a new salon 15%.

Explanation:

We have Annual rate of return = Average Annual Profit / Average Investment;

in which: Average Annual Profit = Average annual revenues - Average annual expenses (including depreciation) = 68,500 - 41,200 = $27,300 (because annual revenues and annual expenses including depreciation are estimated at the same level through out 15 years of the new salon's useful life).

Average investment = (Original investment + Net book value at the end of investment) / 2 = (286,000 + 78,000) / 2 = $182,000 (because Net book value at the end of investment is equal to Estimated salvage value at the end of the salon useful life).

Thus, Annual rate of return = 27,300 / 182,000 = 0.15 = 15%.