Question

Peng Company is considering an investment expected to generate an average net income after taxes of $1,950 for three years. The investment costs $45,000 and has an estimated $6,000 salvage value. Compute the accounting rate of return for this investment; assume the company uses straight-line depreciation.

Answer 1

The Accounting Rate of Return (ARR) of the investment is 7.65%

Step-by-step explanation:

Given,

Average Net Income (After taxes) = $1,950

Investment Cost = $45,000

Salvage Value = $6,000

Computing the Annual Average Investment (AAI) as:

AAI = Initial Investment + Salvage Value / 2

= $45,000 + $6,000 / 2

= $51,000 / 2

= $25,500

Now, Computing the Accounting Rate of Return (ARR) as:

ARR = Average Net Income (after taxes) / Annual Average Investment (AAI)

= $1,950 / $25,500

= 7.65%