Question

Landrum Corporation is considering investing in specialized equipment costing $ 260 comma 000. The equipment has a useful life of 5 years and a residual value of $ 15 comma 000. Depreciation is calculated using the straightminusline method. The expected net cash inflows from the investment​ are: Year 1 $ 60 comma 000 Year 2 $ 90 comma 000 Year 3 $ 110 comma 000 Year 4 $ 40 comma 000 Year 5 $ 25 comma 000 Total cash inflows $ 325 comma 000 Landrum​ Corporation's required rate of return on investments is 20​%. What is the accounting rate of return on the​ investment? A. 4.92​% B. 6.15​% C. 18.85​% D. 25.00​%

Answer 1

6.15%

Step-by-step explanation:

Accounting rate of return is the ratio of average net income of a project and the average investment made in the project.

Accounting rate of return = Average Net income / Average Investment

As per given data

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

As we need to calculate the average net income. The depreciation is added back to calculate the cash flow value. We need to deduct the total depreciation from the total cash flow value to arrive at the net income value.

Total Net Income Value = Total Cash flows - Total Depreciation

Total Net Income Value = $325,000 - ( $260,000 - $15,000 ) = $80,000

Average net income = Total net Income / Numbers of years = $80,000 / 5 = $16,000

Accounting rate of return = (Average annual income / Initial Investment) x 100

Accounting rate of return = ($16,000 / 260,000) x 100 = 6.15%