Question

Palmer Corp. is considering the purchase of a new piece of equipment. The cost savings from the equipment would result in an annual increase in net income after tax of $141,750. The equipment will have an initial cost of $525,000 and have a 7 year life. If the salvage value of the equipment is estimated to be $14,000, what is the accounting rate of return?

a) 149.37%
b) 27.00%
c) 44.11%
d) 16.28

Answer 1

The accounting rate of return (ARR) for Palmer Corp.'s new equipment investment is 52.6%, calculated by dividing the annual increase in net income after tax by the average investment cost and multiplying by 100.

Step-by-step explanation:

To calculate the accounting rate of return (ARR) for Palmer Corp.'s potential purchase of new equipment, the formula \(ARR = \left(\frac{\text{Average Annual Profit}}{\text{Initial Investment}}\right) \times 100\) is used. The relevant figures for the calculation are:

- Initial Investment: $525,000

- Anticipated Annual Increase in Net Income after Tax: $141,750

- Estimated Salvage Value at the End of Equipment's Life: $14,000

The average investment over the equipment's lifespan is calculated as the midpoint between the initial cost and the salvage value:

\[ \text{Average Investment} = \frac{\text{Initial Investment} + \text{Salvage Value}}{2} \]

\[ \text{Average Investment} = \frac{$525,000 + $14,000}{2} = $269,500 \]

Now, substitute these values into the ARR formula:

\[ ARR = \left(\frac{\text{Anticipated Annual Increase in Net Income after Tax}}{\text{Average Investment}}\right) \times 100 \]

\[ ARR = \left(\frac{$141,750}{$269,500}\right) \times 100 \]

Therefore, the accounting rate of return (ARR) for Palmer Corp.'s new equipment purchase is approximately 52.6%. This percentage represents the anticipated return on the average investment over the equipment's lifespan, providing insights into the profitability of the investment.