Bowen is considering the purchase of equipment costing $150,000.The equipment has a 12- year useful life and will generate $25,000 in annual cash flows.The company has a 10% required rate of return and uses the straight-line depreciation method.The accounting rate of return on this equipment is closest to

Question

Quizplus · Accepted Answer

The straight-line method of depreciation means that the equipment's annual depreciation is $150,000/12 = $12,500.

The annual cash flows generated by the equipment are $25,000.

To calculate the accounting rate of return, we need to find the average net income generated by the equipment over its useful life.

The net income each year is the annual cash flow minus the annual depreciation expense:

Year 1: $25,000 - $12,500 = $12,500 
Year 2: $25,000 - $12,500 = $12,500 
... 
Year 12: $25,000 - $12,500 = $12,500

Thus, the total net income over the 12-year useful life of the equipment is:

$12,500 x 12 = $150,000

The average net income is $150,000/12 = $12,500.

To calculate the accounting rate of return, we divide the average net income by the initial investment:

$12,500/$150,000 = 0.0833

Or, as a percentage: 8.33%

Therefore, the closest choice is B, which is 8.3%.

Bowen Is Considering the Purchase of Equipment Costing $150,000