Clapton Corporation is considering an investment in new equipment costing $934,0

Question

Clapton Corporation is considering an investment in new equipment costing $934,000. The equipment will be depreciated on a straight-line basis over a ten-year life and is expected to have a residual value of $90,000. The equipment is expected to generate net cash flows of $156,000 for each of the first five years and $138,000 for each of the last five years. What is the accounting rate of return associated with the equipment investment? (Round your answer to two decimal places.) Select one: O A. 12.23% B. 12.86% C. 13.30% D. 8.25%

Explanation / Answer

Answer is option (A) 12.23%

Explanation;

Total cash flows in 10 years ($156000 * 5) + ($138000 * 5) = $1470000

Total depreciation in 10 years ($934000 – $90000) = $844000

Accounting profit ($1470000 – $844000) = $626000

Thus average annual accounting profit ($626000 / 10) = $62600

Avaerage investment ($934000 + $90000) / 2 = $512000

Now let’s see formula of Accounting Rate of Return;

Accounting rate of return = (Annual accounting profit * 100) / Average investment

Now let’s put the value in the formula;

$62600 * 100 / $512000 = 12.23%

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