Accounting Rate of Return

Exercise 14-27
Accounting Rate of Return

You may use the attached spreadsheet to help you complete this activity, but you are not required to do so. You will find the spreadsheet by clicking on the link in the drop-down menu above.

Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.

a.     Cobre Company is considering the purchase of new equipment that will speed up the process for extracting copper. The equipment will cost $3,600,000 and have a life of five years with no expected salvage value. The expected cash flows associated with the project are as follows:

b.    Emily Hansen is considering investing in one of the following two projects. Either project will require an investment of $75,000. The expected cash revenues minus cash expenses for the two projects follow. Assume each project is depreciable.

c.     Suppose that a project has an ARR of 30 percent (based on initial investment) and that the average net income of the project is $120,000.

d.    Suppose that a project has an ARR of 50 percent and that the investment is $150,000.

1.  Compute the ARR on the new equipment that Cobre Company is considering. Round your answer to one decimal place.
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2.  Conceptual Connection: Which project should Emily Hansen choose based on the ARR? Notice that the payback period is the same for both investments (thus equally preferred).

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Unlike the payback period, explain why ARR correctly signals that one project should be preferred over the other.

The input in the box below will not be graded, but may be reviewed and considered by your instructor.

  _________________  

3.  How much did the company in Scenario c invest in the project? If required, round your answer to the nearest dollar.
$     _________________  

4.  What is the average net income earned by the project in Scenario d? If required, round your answer to the nearest dollar.
$     _________________