A company is planning to purchase a machine that will cost $24,000, have a six-year life, and have no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. Total income over the life of the machine is estimated to be $12,000. The machine will generate cash flows per year of $6,000. The accounting rate of return for the machine is 50%.

Question

Quizplus · Accepted Answer

To calculate the Accounting Rate of Return (ARR), we divide the average annual profit by the initial investment.

ARR = Average Annual Profit / Initial Investment

Average Annual Profit = Total Income / Number of years 
Average Annual Profit = $12,000 / 6 = $2,000 per year

ARR = $2,000 / $24,000 = 0.0833 or 8.33%

Therefore, the accounting rate of return for the machine is 8.33%, not 50%.

A Company Is Planning to Purchase a Machine That Will