Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments.

Rounded to the nearest whole percentage (e.g., 31.349% = 31%), what is the annual accounting (book) rate of return (ARR) based on the initial investment?
A) 12%.
B) 20%.
C) 32%.
D) 36%.
E) 40%.

Question

Pique Corporation wants to purchase a new machine for $300,000. Management predicts that the machine can produce sales of $200,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling $80,000 per year. The firm uses straight-line depreciation with no residual value for all depreciable assets. Pique's combined income tax rate is 40%. Management requires a minimum after-tax rate of return of 10% on all investments.

Rounded to the nearest whole percentage (e.g., 31.349% = 31%) , what is the annual accounting (book) rate of return (ARR) based on the initial investment?

Rounded to the nearest whole percentage (e.g., 31.349% = 31%), what is the annual accounting (book) rate of return (ARR) based on the initial investment? 
A) 12%.
B) 20%.
C) 32%.
D) 36%.
E) 40%.

Quizplus · Accepted Answer

The annual accounting rate of return (ARR) is calculated as the average annual profit after taxes divided by the initial investment. The machine's cost is $300,000, and it depreciates over 5 years with no residual value, so annual depreciation is $60,000 ($300,000 / 5 years). Annual sales are $200,000, and expenses are $80,000, resulting in an operating income of $120,000 ($200,000 - $80,000) before depreciation. Subtracting depreciation gives a profit before taxes of $60,000 ($120,000 - $60,000). With a tax rate of 40%, the after-tax profit is $36,000 ($60,000 - 40% of $60,000). The ARR is the after-tax profit divided by the initial investment: $36,000 / $300,000 = 12%.

Pique Corporation Wants to Purchase a New Machine for $300,000