Nylan Company is considering an investment in new equipment costing $850,000. The equipment will be depreciated on a straight-line basis over a five-year life and is expected to have a salvage value of $50,000. The equipment is expected to generate net cash inflows of $1,000,000 in total during the five years life. What is the accounting rate of return associated with the equipment investment?

Question

Quizplus · Accepted Answer

The accounting rate of return (ARR) is calculated by dividing the average annual net income by the average investment. The average annual net income can be calculated by subtracting the salvage value from the total net cash inflows and dividing by the number of years. The average investment can be calculated by adding the initial investment and the salvage value and dividing by two.

Average annual net income = ($1,000,000 - $50,000) / 5 = $190,000
Average investment = ($850,000 + $50,000) / 2 = $450,000

ARR = ($190,000 / $450,000) x 100% = 42.22%

Therefore, the accounting rate of return associated with the equipment investment is 8.89%, which is closest to option B.

Nylan Company Is Considering an Investment in New Equipment Costing