The management of Indiana Corporation is considering the purchase of a new machine costing $400,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation: The average rate of return for this investment is:

Question

The management of Indiana Corporation is considering the purchase of a new machine costing $400,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability in this situation:  The average rate of return for this investment is:

Quizplus · Accepted Answer

To determine the average rate of return, we need to calculate the total net income and divide it by the total investment.

The total net income can be calculated by subtracting the initial cost of the machine from the total discounted cash flows over the five-year period:

Total discounted cash flows = (0.909 * $200,000) + (0.826 * $220,000) + (0.751 * $240,000) + (0.683 * $260,000) + (0.621 * $280,000) 
Total discounted cash flows = $1,266,050

Total net income = $1,266,050 - $400,000 = $866,050

The average rate of return is then:

Average rate of return = ($866,050 / $400,000) / 5 * 100% 
Average rate of return = 21.65%

Since the average rate of return (21.65%) is greater than the desired rate of return (10%), the investment is acceptable. Therefore, the best choice is B.

The Management of Indiana Corporation Is Considering the Purchase of a New