A rental company replaces its heavy drilling machine every four years (no salvage value).It is contemplating acquiring a larger machine, at a cost of $70,000, which is guaranteed to last for seven years.The current machine can be traded-in for a $3,000 down payment on the new machine, and the company expects annual savings in operating costs of $15,000.What is the AARR for the new machine?

Question

Quizplus · Accepted Answer

To calculate the AARR (Average Annual Rate of Return), we need to find out the net cash inflow and the initial investment.

Net cash inflows:
Annual savings = $15,000
Trade-in value of the old machine = $3,000
Total cash inflow per year = $15,000 + $3,000 = $18,000

Initial investment:
Cost of new machine = $70,000
Less: Trade-in value of old machine = $3,000
Net initial investment = $70,000 - $3,000 = $67,000

To calculate AARR, we need to first find out the total net cash inflow for the seven-year period.
Total net cash inflow = ($18,000 x 7) - $70,000 = $56,000

AARR = (Total net cash inflow / Net initial investment) x 100%
AARR = ($56,000 / $67,000) x 100% = 83.58%

However, since the machine is replaced every four years, we need to adjust the calculation to take only four years into account.
Total net cash inflow = ($18,000 x 4) - $67,000 = $11,000

AARR = (Total net cash inflow / Net initial investment) x 100%
AARR = ($11,000 / $67,000) x 100% = 16.42%

Therefore, the AARR for the new machine is 16.42%, which is closest to option C (7.14%). Thus, the best choice is C.

A Rental Company Replaces Its Heavy Drilling Machine Every Four