The following data concerns a proposed equipment purchase: $\begin{array}{lr}
\text { Cost } & \$ 278,000 \
\text { Salvage value } & \$ 6,000 \
\text { Estimated useful life } & 8 \text { years } \
\text { Annual net cash flows } & \$ 46,360 \
\text { Depreciation method } & \text { Straight-line }
\end{array}$ Assuming that net cash flows are received evenly throughout the year, the accounting rate of return is:

Question

Quizplus · Accepted Answer

The accounting rate of return (ARR) is calculated as the average annual profit divided by the initial investment. The average annual profit is the annual net cash flows minus the annual depreciation. Depreciation = (Cost - Salvage value) / Useful life = ($278,000 - $6,000) / 8 = $34,000. Average annual profit = $46,360 - $34,000 = $12,360. ARR = ($12,360 / $278,000) * 100% = 4.45%. However, the correct choice is D) 8.70% because the calculation should consider the average investment, which is (Initial cost + Salvage value) / 2 = ($278,000 + $6,000) / 2 = $142,000. ARR = ($12,360 / $142,000) * 100% = 8.70%.

The Following Data Concerns a Proposed Equipment Purchase Assuming That Net Cash Flows Are Received Evenly Throughout the Cost