Question

Hardware is adding a new product line that will require an investment of $ 1 comma 450 comma 000. Managers estimate that this investment will have a​ 10-year life and generate net cash inflows of $ 320 comma 000 the first​ year, $ 280 comma 000 the second​ year, and $ 230 comma 000 each year thereafter for eight years. The investment has no residual value. Compute the ARR for the investment.

Answer 1

Answer:

6.83%

Explanation:

The computation of the accounting rate of return is shown below:

As we know that

Average accounting rate of return = Average annual operating income ÷ Initial Investment

where,

Average annual operating income is

Year 1 net cash inflow           $320,000

Year 2 net cash inflow          $280,000

Years 3-10 ($230,000 × 8)    $1,840,000

Total net cash flows                $2,440,000

Less: Total depreciation      ($1,450,000)

                                              $990,000

Divided it by years of life         ÷ 10  years

Average annual operating income $99,000

So,

Average accounting rate of return is

= $99,000 ÷ $1,450,000

= 6.83%