Question

Accounting Rate of Return Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows. Cobre Company is considering the purchase of new equipment that will speed up the process for extracting copper. The equipment will cost $3,600,000 and have a life of 5 years with no expected salvage value. The expected cash flows associated with the project are as follows: Year Cash Revenues Cash Expenses 1 $6,000,000 $4,800,000 2 6,000,000 4,800,000 3 6,000,000 4,800,000 4 6,000,000 4,800,000 5 6,000,000 4,800,000 Emily Hansen is considering investing in one of the following two projects. Either project will require an investment of $75,000. The expected cash revenues minus cash expenses for the two projects follow. Assume each project is depreciable. Year Project A Project B 1 $22,500 $22,500 2 30,000 30,000 3 45,000 45,000 4 75,000 22,500 5 75,000 22,500 Suppose that a project has an ARR of 30% (based on initial investment) and that the average net income of the project is $120,000. Suppose that a project has an ARR of 50% and that the investment is $150,000. Required: 1. Compute the ARR on the new equipment that Cobre Company is considering. Round your answer to one decimal place. % 2. Conceptual Connection: Which project should Emily Hansen choose based on the ARR

Answer 1

Answer:

       Computation of Accounting Profit of the new project

Years        Cash Revenue        Cash expenses  Depreciation      Profit

1                  $6,000,000           $4,800,000         720,000         480,000

2                  6,000,000             4,800,000           720,000        480,000

3                  6,000,000            4,800,000            720,000        480,000

4                  6,000,000             4,800,000          720,000        480,000

5                 6,000,000             4,800,000           720,000         480,000

Accounting rate of return of the new project

                                         =  Average Profit / Initial  investment

                                       =  $480,000/$3,600,000

                                       =  13.3%

2. Project A 's ARR =  30%

   Project B's  ARR = 50%

 New Project's ARR   =  13.3%

Emily Hansen should choose project with highest ARR. Therefore, project B should be selected since it has highest ARR of 50% as compare to others.

                                       

Explanation: