The management of River Corporation is considering the purchase of a new machine costing $380,000. The company's desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5 years is 4.212. 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 River Corporation is considering the purchase of a new machine costing $380,000. The company's desired rate of return is 6%. The present value factor for an annuity of $1 at interest of 6% for 5 years is 4.212. 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 calculate the average rate of return, we need to divide the expected annual cash inflows by the initial investment. From the table, we see that the expected annual cash inflows are $95,000 for the next five years. Therefore, the total expected cash inflows are $475,000 ($95,000 x 5 years). The initial investment is $380,000. Thus, the average rate of return is ($475,000 - $380,000) / $380,000, which is 0.25 or 25%. Since the desired rate of return is 6%, this investment is acceptable as the average rate of return of 25% is greater than the desired rate of return of 6%. Therefore, the best choice is B.

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