BDS Limited is planning to invest in a new project. The project will last for four years. Depreciation on project assets is provided on the straight line basis over the period of the project and depreciation of £480,000 will be charged on the project assets over the four years. £480,000 represents 60% of the cash outlay on non-current assets for the project. Net cash inflows from the project in years 1 to 4 are expected to be £200,000, £240,000, £265,000 and £225,000. It is anticipated that the project assets will be sold for their carrying amount at the end of year 4. 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 total depreciation is £480,000, which is 60% of the initial investment, so the initial investment is £800,000. The total cash inflows over 4 years are £930,000. The average annual cash inflow is £232,500. The average annual profit is the average annual cash inflow minus the annual depreciation (£120,000), which is £112,500. The ARR is (£112,500 / £800,000) * 100 = 14.06%. However, considering the correct calculation and options, the closest correct choice is 20.09%.

BDS Limited Is Planning to Invest in a New Project