Mahtomedi Corporation is considering investing in specialized equipment costing $240,000.The equipment has a useful life of 5 years and a residual value of $20,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are: $$\begin{array} { | l | c | }
\hline \text { Year 1 } & \$ 60,000 \
\hline \text { Year 2 } & \$ 90,000 \
\hline \text { Year 3 } & \$ 110,000 \
\hline \text { Year 4 } & \$ 40,000 \
\hline \text { Year 5 } & \$ 25,000 \
\hline \text { Tutal cash inflows } & \$ 325,000 \
\hline
\end{array}$$ Mahtomedi Corporation's required rate of return on investments is 14%.
What is the accounting rate of return on the investment?

Question

Mahtomedi Corporation is considering investing in specialized equipment costing $240,000.The equipment has a useful life of 5 years and a residual value of $20,000.Depreciation is calculated using the straight-line method.The expected net cash inflows from the investment are: $$\begin{array} { | l | c | } 
\hline \text { Year 1 } & \$ 60,000 \
\hline \text { Year 2 } & \$ 90,000 \
\hline \text { Year 3 } & \$ 110,000 \
\hline \text { Year 4 } & \$ 40,000 \
\hline \text { Year 5 } & \$ 25,000 \
\hline \text { Tutal cash inflows } & \$ 325,000 \
\hline
\end{array}$$ Mahtomedi Corporation's required rate of return on investments is 14%.
What is the accounting rate of return on the investment?

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 total cash inflows minus the total depreciation, divided by the number of years. Depreciation is ($240,000 - $20,000) / 5 = $44,000 per year. Total cash inflows are $325,000, so the average annual profit is ($325,000 - $220,000) / 5 = $21,000. ARR = $21,000 / $240,000 = 8.75%.

Mahtomedi Corporation Is Considering Investing in Specialized Equipment Costing $240,000