A project requires an investment of $40,000 in equipment. Annual cash flows of $8,000 are expected to occur for the next eight years. No salvage value is expected. The company uses the straight-line method of depreciation with no mid-year convention. Ignore income taxes. The accounting rate of return on the original investment for the project is

Question

Quizplus · Accepted Answer

The accounting rate of return (ARR) is calculated by dividing the average annual profit by the initial investment. The average annual profit is the annual cash flow minus the annual depreciation. Depreciation is $40,000/8 = $5,000 per year. Thus, the average annual profit is $8,000 - $5,000 = $3,000. ARR = ($3,000 / $40,000) * 100% = 7.50%.

A Project Requires an Investment of $40,000 in Equipment