Question

ABC Company is considering investing in new production equipment at a cost of $60,000 with a 10-year useful life and no salvage value. The following are estimated for Year 1 of the project:

Sales = $100,000 Production costs = $82,600 Depreciation expense = $6,000

Calculate the following for ABC Company for Year 1:
a. Operating income =
b. Average investment =
c. Accounting rate of return =

Answer 1

a. Operating Income = Sales - Production Cost - Depreciation Expense

Operating Income = $100,000 - $82,600 - $6,000

Operating Income = $11,400

b. Average Investment = (Initial Equipment Cost + Residual Value) / 2

Average Investment = ($60,000 + $0) / 2

Average Investment = $60,000 / 2

Average Investment = $30,000

c. Accounting Rate of Return = (Operating Income / Average Investment) * 100

Accounting Rate of Return = ($11,400 / $30,000) * 100

Accounting Rate of Return = 0.38 * 100

Accounting Rate of Return = 38%