Question

Landrum Corporation is considering investing in specialized equipment costing​ $250,000. The equipment has a useful life of 5 years and a residual value of​ $20,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment​ are:
Year 1 $60,000
Year 2 $90,000
Year 3 $110,000
Year 4 $40,000
Year 5 $25,000
Total cash inflows $325,000
Landrum​ Corporation's required rate of return on investments is​ 14%.What is the accounting rate of return on the​ investment?
A. 44.40%
B. 5.60%
C. 7.60%
D.18.40%

Answer 1

Answer: ARR = Average profit/Initial outlay x 100

               ARR = $19,000/$250,000 x 100

               ARR = 7.60%

The correct answer is C

               

               Depreciation = Cost - Residual value/Estimated useful life

                                       = $250,000 - $20,000/5 years

                                       = $46,000 per annum

               Average profit = Total profit/No of years

                                         = $325,000/5

                                         = $65,000

                                                                       $

              Average profit                           65,000

        Less: Depreciation                           46,000

       Average profit after depreciation   19,000

Explanation: In determining the accounting rate of return of the investment, there is need to calculate depreciation using straight line method. The amount of depreciation would be deducted from the average profit so as to obtain the average profit after depreciation. The average profit would be divided by the initial outlay in order to obtain the accounting rate of return.