Martin Production Co is considering investing in specialized equipment costing $975,000
The equipment has a useful life of five years and a residual value of $75,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment are given below:
Year 1 $275,000
Year 2 220,000
Year 3 200,000
Year 4 200,000
Year 5 180,000
$1,075,000
Compute the accounting rate of return on the investment, Show your calculations and round to two decimal places.
What will be an ideal response
Calculation of accounting rate of return:
Total net cash inflows during operating life of the asset $1,075,000
Less: Total depreciation during operating life of the asset
($975,000 - $75,000 ) 900,000
Total operating income during operating life of the asset $175,000
Divide by: Asset's operating life in years / 5
Average annual operating income from asset $35,000
Average amount invested* [($975,000 + $75,000 ) / 2] $525,000
*Average amount invested = (Amount invested + Residual value) / 2
ARR of Equipment = Average annual operating income / Average amount invested
= $35,000 / $525,000 = 6.67% (Rounded)
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