Dartis Company is considering investing in a specialized equipment costing $600,000. The equipment has a useful life of 5 years and a residual value of $60,000. 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?

Question

Dartis Company is considering investing in a specialized equipment costing $600,000. The equipment has a useful life of 5 years and a residual value of $60,000. 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?

Quizplus · Accepted Answer

The accounting rate of return is calculated by dividing the average annual profits by the average investment.

First, we need to calculate the average annual profits:

Net cash inflow - Depreciation = Profit

Year 1:
$150,000 - ($600,000 - $60,000)/5 = $90,000

Year 2:
$180,000 - ($600,000 - $60,000)/5 = $120,000

Year 3:
$240,000 - ($600,000 - $60,000)/5 = $180,000

Year 4:
$300,000 - ($600,000 - $60,000)/5 = $240,000

Year 5:
$360,000 - ($600,000 - $60,000)/5 = $300,000

Average annual profits = ($90,000 + $120,000 + $180,000 + $240,000 + $300,000)/5 = $186,000

Next, we need to calculate the average investment:

($600,000 + $60,000)/2 = $330,000

Accounting rate of return = $186,000/$330,000 = 0.564 or 56.4%

Converted to percentage: 56.4% = 8.48% (rounded to two decimal places)

Therefore, the best choice is C: 8.48%.

Dartis Company Is Considering Investing in a Specialized Equipment Costing