Project Y is a two- year project that involves the purchase of new machinery for $100 million,that is expected to yield EBDIT of $59 million in year 1 and $80 million in year two.For tax purposes the machine can be depreciated on a straight- line basis.The current corporate tax rate is 33%.What is the project's ARR?
A)39%
B)19%
C)46%
D)26%

Question

Quizplus · Accepted Answer

ARR = Average Annual Accounting Profit / Initial Investment

EBDIT (year 1 & 2) = $59 million + $80 million = $139 million
Depreciation Expense = $100 million / 2 = $50 million per year
EBT = EBDIT - Depreciation = $139 million - $50 million - $50 million = $39 million
Income Tax Expense = $39 million * 0.33 = $12.87 million
Net Income = EBT - Income Tax Expense = $26.13 million
Average Annual Accounting Profit = ($26.13 million + $80 million) / 2 = $53.07 million

ARR = $53.07 million / $100 million = 53.07%

However, since the corporate tax rate is taken into account in calculating ARR, it may be more appropriate to use the after-tax net income in the calculation:

After-Tax Net Income = Net Income - Income Tax Expense = $26.13 million

After-Tax ARR = After-Tax Net Income / Initial Investment = $26.13 million / $100 million = 26.13%

Based on this calculation, Choice D is the best answer.

Project Y Is a Two- Year Project That Involves the Purchase