Question

nelson corporation is considering the purchase of a new piece of equipment. the cost savings from the equipment would result in an annual increase in net cash flow of $100,000. the equipment will have an initial cost of $400,000 and have a 5-year useful life. if the salvage value of the equipment is estimated to be $75,000, what is the accounting rate of return? multiple choice 6.25% 8.75% 25.00% 26.67%

Answer 1

The Accounting Rate of Return for Nelson Corporation's new equipment is calculated using the net cash flow, salvage value, and initial cost, resulting in an ARR of 8.75%.

Step-by-step explanation:

The Accounting Rate of Return (ARR) is calculated by dividing the average annual operating income from an asset by the initial investment cost. The Nelson Corporation expects an annual increase in net cash flow of $100,000 from the new equipment, which costs $400,000 and has a salvage value of $75,000 after a useful life of 5 years. To find the ARR, we first calculate the average annual operating income, which is the annual net cash flow adjusted for the equipment's depreciation.

The depreciation expense is calculated as (Initial Cost - Salvage Value) / Useful Life, which amounts to ($400,000 - $75,000) / 5 or $65,000 per year. Therefore, the average annual operating income is $100,000 - $65,000 = $35,000. The ARR is then the average annual operating income divided by the initial cost of the equipment, which yields an ARR of $35,000 / $400,000 = 0.0875 or 8.75%.