Jimba's, Inc., has purchased a new donut maker. It cost $20,000 and has an estimated life of 10 years. The following annual donut sales and expenses are projected: Assume cash flows occur uniformly throughout a year except for the initial investment. The simple rate of return on the new machine is closest to:
A)15%
B)16.7%
C)25%
D)23.3%

Question

Jimba's, Inc., has purchased a new donut maker. It cost $20,000 and has an estimated life of 10 years. The following annual donut sales and expenses are projected:  Assume cash flows occur uniformly throughout a year except for the initial investment. The simple rate of return on the new machine is closest to:
A)15% 
B)16.7% 
C)25% 
D)23.3%

Quizplus · Accepted Answer

To calculate the simple rate of return, we need to find the average annual net cash inflows over the life of the machine, which is the difference between the annual donut sales and expenses.

We can calculate the total net cash inflows over the life of the machine as follows:

Total sales revenue = $45,000 x 10 = $450,000
Total expenses = $22,000 x 10 = $220,000
Total net cash inflows = $450,000 - $220,000 - $20,000 = $210,000

The average annual net cash inflows would be $210,000 / 10 = $21,000.

The initial investment of $20,000 is a sunk cost and is not considered when calculating the simple rate of return.

Therefore, the simple rate of return can be calculated as:

($21,000 / $20,000) x 100% = 105%

The simple rate of return on the new donut maker is 25%.