Sayer Tool Co. is considering investing in specialized equipment costing $610,000. The equipment has a useful life of five years and a residual value of $69,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment are given below. What is the Accounting Rate of Return on the investment? $$\begin{array} { | c c | }
\hline \text { Year } & \
\hline 1 & \$ 210,000 \
\hline 2 & \$ 159,000 \
\hline 3 & \$ 160,000 \
\hline 4 & \$ 95,000 \
\hline 5 & \$ 136,000 \
\hline \text { Total } & \$ 760,000 \
\hline
\end{array}$$

Question

Sayer Tool Co. is considering investing in specialized equipment costing $610,000. The equipment has a useful life of five years and a residual value of $69,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment are given below. What is the Accounting Rate of Return on the investment? $$\begin{array} { | c c | } 
\hline \text { Year } & \
\hline 1 & \$ 210,000 \
\hline 2 & \$ 159,000 \
\hline 3 & \$ 160,000 \
\hline 4 & \$ 95,000 \
\hline 5 & \$ 136,000 \
\hline \text { Total } & \$ 760,000 \
\hline
\end{array}$$

Quizplus · Accepted Answer

The Accounting Rate of Return (ARR) is calculated as the average annual profit from the investment divided by the initial investment cost. First, calculate the annual depreciation: $(610,000 - 69,000) / 5 = 108,200$. The total net cash inflows over the 5 years is $760,000, so the average annual net cash inflow is $760,000 / 5 = $152,000. Subtract the annual depreciation from the average annual net cash inflow to get the average annual profit: $152,000 - $108,200 = $43,800. Finally, divide the average annual profit by the initial investment cost: $43,800 / $610,000 = 0.0718 or 7.18%. However, the correct calculation should consider the average investment, which is $(610,000 + 69,000) / 2 = 339,500$, leading to an ARR of $43,800 / 339,500 = 0.129 or 12.9%. The mistake in the explanation is the incorrect base for the ARR calculation; it should be based on the average investment rather than the initial cost.

Sayer Tool Co A) 00645 B) 0

Sayer Tool Co A) 00645
B) 0