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Sunny Flowers is considering the purchase of a small business that costs $500,000. Sunny plans to sell stock valued at $250,000. The stock would pay dividends of $20,000 per year. Sunny would borrow the remaining $250,000 from a local bank at 12 percent interest.
The business is expected to generate annual cash inflows of $80,000. Duane plans to operate the business for 15 years and then turn it over to his son.
-If the depreciation is $25,000 per year, the accounting rate of return based on the initial investment is
A) 11%.
B) 12%.
C) 16%.
D) 17.2%.

Question

Quizplus · Accepted Answer

The accounting rate of return (ARR) is calculated as the average annual profit divided by the initial investment. The annual profit is the cash inflow minus interest and depreciation. Here, the profit is $80,000 - ($250,000 * 12%) - $25,000 = $80,000 - $30,000 - $25,000 = $25,000. The ARR is $25,000 / $500,000 = 5%. However, the question seems to have a mistake in the options provided, as none match this calculation.

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