A company projects an increase in net income of $225,000 each year for the next five years if it invests $900,000 in new equipment. The equipment has a five-year life and an estimated salvage value of $300,000. What is the annual rate of return on this investment?

Question

Quizplus · Accepted Answer

To calculate the annual rate of return, we need to use the following formula:
Annual rate of return = (Total net income from investment + Salvage value - Initial investment)/Initial investment 
Total net income from investment = Increase in net income each year x number of years = $225,000 x 5 = $1,125,000 
Salvage value = $300,000 
Initial investment = $900,000 
Annual rate of return = ($1,125,000 + $300,000 - $900,000)/$900,000 = 0.375 or 37.5% 
Therefore, the best choice is B.

A Company Projects an Increase in Net Income of $225,000