A company is considering the purchase of a new machine for $48,000. Management predicts that the machine can produce sales of $16,000 each year for the next 10 years. Expenses are expected to include direct materials, direct labor, and factory overhead totaling $8,000 per year plus depreciation of $4,000 per year. The company's tax rate is 40%. What is the approximate Accounting Rate of Return for the machine?

Question

Quizplus · Accepted Answer

The Accounting Rate of Return (ARR) is calculated as the average annual profit divided by the initial investment. The annual profit is sales ($16,000) minus expenses ($8,000) and depreciation ($4,000), which equals $4,000. After tax, the profit is $4,000 * (1 - 0.40) = $2,400. The ARR is $2,400 / $48,000 = 0.05 or 5%. However, considering the depreciation is not a cash expense, the ARR is calculated on the pre-tax profit of $4,000, leading to an ARR of $4,000 / $48,000 = 0.0833 or approximately 8%.

A Company Is Considering the Purchase of a New Machine