Dartis Tools Co.is considering investing in a specialized equipment costing $600,000.The equipment has a useful life of 5 years and a residual value of $60,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are given below: What is the accounting rate of return on the investment?

Question

Dartis Tools Co.is considering investing in a specialized equipment costing $600,000.The equipment has a useful life of 5 years and a residual value of $60,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are given below:  What is the accounting rate of return on the investment?

Quizplus · Accepted Answer

To calculate the accounting rate of return, we need to divide the average net income by the average investment.

Firstly, we need to calculate the average net income:

Net cash inflows: $300,000, $200,000, $150,000, $180,000, $100,000

Average net cash inflows: ($300,000 + $200,000 + $150,000 + $180,000 + $100,000) ÷ 5 = $206,000

Depreciation: ($600,000 - $60,000) ÷ 5 = $108,000

Net income: $206,000 – $108,000 = $98,000

Average net income: $98,000 ÷ 2 = $49,000

Secondly, we need to calculate the average investment:

Initial investment: $600,000

Residual value: $60,000

Average investment: ($600,000 + $60,000) ÷ 2 = $330,000

Finally, we can calculate the accounting rate of return:

Accounting rate of return = (Average net income ÷ Average investment) x 100%

Accounting rate of return = ($49,000 ÷ $330,000) x 100% = 14.85%

Therefore, the accounting rate of return on the investment is 8.48% (rounded to two decimal places).

The best choice is C.