Coriander Company is considering a project with an initial investment of $426,800 in new equipment that will yield annual net cash flows of $80,000, and will be depreciated at $53,350 per year over its eight year life. What is the accounting rate of return?

Question

Quizplus · Accepted Answer

Accounting rate of return (ARR) is calculated as average annual profit divided by the average investment. In this case, the average annual profit is the average of the net cash flows over the equipment's life and the average investment is the initial investment plus the salvage value divided by 2.

Average annual profit: 
Net cash flows per year = $80,000
Depreciation per year = $53,350
Therefore, average annual profit = ($80,000 - $53,350)/2 = $13,325

Average investment:
Initial investment = $426,800
Salvage value = $0 (assuming equipment has no salvage value after 8 years)
Therefore, average investment = ($426,800 + $0)/2 = $213,400

ARR = Average annual profit / Average investment
ARR = $13,325 / $213,400
ARR = 6.24%

Therefore, the accounting rate of return is 6.24%, making option C the best choice.

Coriander Company Is Considering a Project with an Initial Investment