Bowen is considering the purchase of equipment costing $150,000.The equipment has a 12- year useful life, has an estimated salvage value of zero, and is expected to generate $25,000 in annual cash flows.The company has a 10% required rate of return and uses the straight-line depreciation method.The accounting rate of return on this equipment is closest to
A)1.6%.
B)8.3%.
C)10%.
D)25%.

Question

Quizplus · Accepted Answer

First, we need to calculate the annual depreciation expense using the straight-line method, which is (cost - salvage value) / useful life = ($150,000 - $0) / 12 = $12,500 per year.

Next, we need to calculate the annual net cash inflows, which are $25,000 - $12,500 = $12,500 per year.

Using the formula for accounting rate of return, which is average annual net income / initial investment, we can calculate the ARR:

Average annual net income = ($25,000 - $12,500) / 2 = $6,250
Initial investment = $150,000

ARR = $6,250 / $150,000 = 0.0417 = 4.17%

However, the question asks for the accounting rate of return as a percentage of the required rate of return, which is 10%. Therefore, we need to divide the ARR by the required rate of return:

4.17% / 10% = 0.417 = 41.7%

The closest answer choice to this is B (8.3%).

Bowen Is Considering the Purchase of Equipment Costing $150,000