Spaniel Company is considering the purchase of a new machine for $80,000. The machine would generate an annual cash flow before depreciation and taxes of $28,778 for five years. At the end of five years, the machine would have no salvage value. The company's cost of capital is 12 percent. The company uses straight-line depreciation with no mid-year convention and has a 40 percent tax rate. What is the accounting rate of return on the original investment in the machine approximated to two decimal points?

Question

Quizplus · Accepted Answer

The accounting rate of return is calculated by dividing the average annual accounting income by the initial investment. The average annual accounting income is calculated by subtracting depreciation and taxes from the annual cash flow before depreciation and taxes. Depreciation is calculated by dividing the cost of the machine by its useful life. Taxes are calculated by multiplying the taxable income by the tax rate. The initial investment is the cost of the machine.In this case, the average annual accounting income is calculated as follows:Average annual accounting income = (Annual cash flow before depreciation and taxes - Depreciation - Taxes) / 2= ($28,778 - $16,000 - $5,115) / 2= $3,832The initial investment is $80,000. Therefore, the accounting rate of return is calculated as follows:Accounting rate of return = Average annual accounting income / Initial investment= $3,832 / $80,000= 0.048 or 4.8%

Spaniel Company Is Considering the Purchase of a New Machine