Randy Ritchie is considering investing $20,000 in a project with the following annual cash revenues and expenses: Depreciation will be $4,000 per year.
What is the accounting rate of return on the investment?
$$\begin{array} { l r r }
& \begin{array} { r }
\text { Cash } \
\text { Revenues }
\end{array} & \begin{array} { r }
\text { Cash } \
\text { Expenses }
\end{array} \
\text { Year 1 } & \$ 8,000 & \$ 8,000 \
\text { Year 2 } & \$ 12,000 & \$ 8,000 \
\text { Year 3 } & \$ 15,000 & \$ 9,000 \
\text { Year 4 } & \$ 20,000 & \$ 10,000 \
\text { Year 5 } & \$ 20,000 & \$ 10,000
\end{array}$$

Question

Randy Ritchie is considering investing $20,000 in a project with the following annual cash revenues and expenses: Depreciation will be $4,000 per year.
What is the accounting rate of return on the investment?
$$\begin{array} { l r r } 
& \begin{array} { r } 
\text { Cash } \
\text { Revenues }
\end{array} & \begin{array} { r } 
\text { Cash } \
\text { Expenses }
\end{array} \
\text { Year 1 } & \$ 8,000 & \$ 8,000 \
\text { Year 2 } & \$ 12,000 & \$ 8,000 \
\text { Year 3 } & \$ 15,000 & \$ 9,000 \
\text { Year 4 } & \$ 20,000 & \$ 10,000 \
\text { Year 5 } & \$ 20,000 & \$ 10,000
\end{array}$$

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 average of net income, which is revenues minus expenses and depreciation. First, calculate the net income for each year, then find the average, and finally calculate ARR.Year 1: $8,000 - $8,000 - $4,000 = -$4,000Year 2: $12,000 - $8,000 - $4,000 = $0Year 3: $15,000 - $9,000 - $4,000 = $2,000Year 4: $20,000 - $10,000 - $4,000 = $6,000Year 5: $20,000 - $10,000 - $4,000 = $6,000Total net income over 5 years = -$4,000 + $0 + $2,000 + $6,000 + $6,000 = $10,000Average annual profit = $10,000 / 5 = $2,000ARR = (Average annual profit / Initial investment) * 100 = ($2,000 / $20,000) * 100 = 10%

Randy Ritchie Is Considering Investing $20,000 in a Project with the Following