Chiller Time wants to purchase a new ice cream truck which costs $56,000. The company has a cost of capital of 8%, required rate of return of 10%, and the prevailing income tax rate is 30%. The acquisition is proposed for January 1, 2014. Chiller Time expects it can sell the truck for $8,000 at end of its useful life of 4 years. Chiller Time predicts the new truck will generate net income of $5,000 and operating cash flows of $17,000 during 2014, with an increase of 5% each subsequent year. What is the accounting rate of return?

Question

Quizplus · Accepted Answer

The formula for accounting rate of return is average annual income from investment divided by the average investment, expressed as a percentage. Average annual income for the 4-year investment period is (5,000+5,250+5,513+5,788)/4 = $5,388. Average investment is ($56,000+$8,000)/2 = $32,000. Therefore, accounting rate of return = (5,388/32,000) x 100% = 16.8%. Therefore, the best choice is B.

Chiller Time Wants to Purchase a New Ice Cream Truck