An investment cost $80,000 with no salvage value,a 5-year useful life,and had an expected annual increase in net income of $7,000.Straight-line depreciation is used.What is the expected return on average investment?

Question

Quizplus · Accepted Answer

First, we need to calculate the depreciation expense per year:
Depreciation expense = (Cost - Salvage value) / Useful life
Depreciation expense = ($80,000 - $0) / 5 years = $16,000 per year

Next, we can calculate the expected net income for each year:
Year 1: $7,000
Year 2: $7,000 + $7,000 = $14,000
Year 3: $7,000 + $14,000 = $21,000
Year 4: $7,000 + $21,000 = $28,000
Year 5: $7,000 + $28,000 = $35,000

We can now calculate the average annual net income:
Total net income / Useful life = $105,000 / 5 years = $21,000 per year

Finally, we can calculate the expected return on average investment:
Expected return on average investment = Average annual net income / Initial investment
Expected return on average investment = $21,000 / $80,000 = 0.2625 or 26.25%

However, since straight-line depreciation is used, the initial investment is spread equally over the useful life of the asset. Therefore, the book value of the asset at the end of its useful life will be zero. This means that the average investment over the 5-year period is actually $40,000 ($80,000 / 2). With this in mind, we can recalculate the expected return on average investment as follows:

Expected return on average investment = Average annual net income / Average investment
Expected return on average investment = $21,000 / $40,000 = 0.525 or 52.5%

Therefore, the best choice is C) 17.5%.

An Investment Cost $80,000 with No Salvage Value,a 5-Year Useful