Question

Knowledge Check 01 Addison Corporation is considering the purchase of equipment that would increase sales revenues by $250,000 per year and cash operating expenses by $100,000 per year. The equipment would cost $400,000 and have a 5-year life with no salvage value. The simple rate of return on the investment is closest to ________. 17.5% 20.0% 25.5% 35.0%

Answer 1

the simple rate of return on the investment is closest to

15.2%

Answer 2

The answer is 17.5%

Step-by-step explanation:

Using Accounting Rate of Return (ARR)

ARR= Average Annual Accounting Profit/Average Investment ×100%

ARR = 70,000/400,000× 100% = 17.5%

Average Accounting Profit ?

$

Sales Revenue 250,000

Cash Operating Expenses (100,000)

Cash flow 150,000

Depreciation Charge (See working) 80,000

Average Accounting Profit 70,000

Average Investment cost =$400,000 (Since scrap value is nil)

Working

Depreciation ( Using straight line method)

Annual charge =400,000/5 yrs = $ 80,000.

ARR is used to measure relative project profitability .It is relative simple to calculate and interpret by the management.

It however ignores time value of money which is one of its greatest limitation.