Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.

The hurdle rate for accepting new capital investment projects is 4%, after-tax. The estimated accounting rate of return (ARR) on this project (rounded to two decimal points), based on the initial investment is:
A) 2.67%.
B) 3.33%.
C) 6.67%.
D) 10.00%.
E) 12.00%.

Question

Brandon Company is contemplating the purchase of a new piece of equipment for $45,000. Brandon is in the 30% income tax bracket. Predicted annual after-tax cash inflows from this investment are $18,000, $15,000, $9,000, $6,000 and $3,000 for years 1 through 5, respectively. The firm uses straight-line depreciation with no residual value at the end of five years.

The hurdle rate for accepting new capital investment projects is 4%, after-tax. The estimated accounting rate of return (ARR) on this project (rounded to two decimal points) , based on the initial investment is:

The hurdle rate for accepting new capital investment projects is 4%, after-tax. The estimated accounting rate of return (ARR) on this project (rounded to two decimal points), based on the initial investment is:
A) 2.67%.
B) 3.33%.
C) 6.67%.
D) 10.00%.
E) 12.00%.

Quizplus · Accepted Answer

The accounting rate of return (ARR) is calculated by dividing the average annual accounting income by the initial investment. The average annual accounting income is calculated by subtracting the annual depreciation expense from the annual after-tax cash inflows. The annual depreciation expense is calculated by dividing the initial investment by the number of years over which the asset is depreciated. In this case, the initial investment is $45,000 and the asset is depreciated over 5 years, so the annual depreciation expense is $9,000. The average annual accounting income is therefore calculated as follows:Average annual accounting income = ($18,000 + $15,000 + $9,000 + $6,000 + $3,000) / 5 - $9,000 = $6,000The ARR is then calculated as follows:ARR = Average annual accounting income / Initial investment = $6,000 / $45,000 = 13.33%Therefore, the estimated accounting rate of return (ARR) on this project, based on the initial investment, is 13.33%, which is closest to choice A, 2.67%.

Brandon Company Is Contemplating the Purchase of a New Piece