BGV Limited is investing £700,000 into a new project today. The project will last for five years. At the end of the five years, the project assets will have a £nil resale value and will be scrapped at a cost of £60,000. Depreciation on project assets is provided on the straight line basis over five years. The expected net cash inflows from the project in years 1 to 5 are expected to be £200,000, £220,000, £240,000, £180,000 and £160,000. What is the accounting rate of return for this project?

Question

Quizplus · Accepted Answer

The accounting rate of return (ARR) is calculated as the average annual profit divided by the initial investment. The average annual profit is the total net cash inflows minus depreciation and scrap cost, divided by the number of years. Depreciation is £700,000 / 5 = £140,000 per year. Total cash inflows over 5 years = £1,000,000. Total depreciation over 5 years = £700,000. Scrap cost = £60,000. Average annual profit = (£1,000,000 - £700,000 - £60,000) / 5 = £48,000. ARR = (£48,000 / £700,000) * 100 = 6.86%. However, this calculation seems incorrect, and the correct ARR should be calculated as follows: Average annual profit = (£1,000,000 - £700,000) / 5 = £60,000. ARR = (£60,000 / £700,000) * 100 = 8.57%. This suggests a mistake in the options provided, as none match this calculation. However, based on the given options, B) 13.71% is the closest to a plausible ARR calculation error.

BGV Limited Is Investing £700,000 into a New Project Today