Chapter 26: Q21E (page 1469)

Using ARR to make capital investment decisions Refer to the Henry Hardware information in Exercise E26-20. Assume the project has no residual value. Compute the ARR for the investment. Round to two places.
Henry Hardware is adding a new product line that will require an investment of $1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of $310,000 the first year, $270,000 the second year, and $240,000 each year thereafter for eight years.

Short Answer

Expert verified

ARR is 13.07%

Step by step solution

Meaning of ARR

ARR depicts the effect of the investment on the company's accrual-based income. The accounting rate of return could be a proportion that does not consider the thought of time worth of cash.

Computing the ARR for the investment

$\begin{array}{rcl} T o t a l n e t c a s h i n f l o w s s u r i n g o p e r a t i n g l i f e o f p r o j e c t & = & S u m o f n e t c a s h i n f l o w s d u r i n g o p e r a t i n g l i f e o f p r o j e c t \\ = & $ 310, 000 Y r . 1 + $ 270, 000 Y r . 2 + (240, 000 \times 8 y r s .) \\ = & $ 2.500, 000 \end{array}$

$\begin{array}{rcl} T o t a l d e p r e c i a t i o n d u r i n g o p e r a t i n g l i f e o f p r o j e c t & = & C o s t - R e s i d u a l v a l u e \\ = & $ 1, 512, 000 - $ 0 \\ = & $ 1, 512, 000 \end{array}$

Average annual operating income

Total net cash inflows during the operating life of the project	$2,500,000
Less: Total depreciation during the operating life of the project	1,512,000
Total operating income during the operating life	988,000
Divide by: Project’s operating life in years	10 years
Average annual operating income from the project	$ 98,800

$\begin{array}{rcl} A v e r a g e a m o u n t i n v e s t e d & = & \frac{A m o u n t i n v e s t e d + R e s i d u a l v a l u e}{2} \\ = & \frac{$ 1, 512, 000 + $ 0}{2} \\ = & $ 756, 000 \end{array}$

$\begin{array}{rcl} A R R & = & \frac{A v e r a g e a n n u a l o p e r a t i o n I n c o m e}{A v e r a g e a m o u n t i n v e s t e d} \\ = & \frac{$ 98, 800}{$ 756, 000} \\ = & 13.07 % (r o u n d e d) \end{array}$

Unlock Step-by-Step Solutions & Ace Your Exams!

Full Textbook Solutions
Get detailed explanations and key concepts
Unlimited Al creation
Al flashcards, explanations, exams and more...
Ads-free access
To over 500 millions flashcards
Money-back guarantee
We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

Recommended explanations on Business Studies Textbooks

View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

	Equipment A	Equipment B	Equipment C
Present value of net cash inflows	\(1,647,351	\)1,969,888	\(2,064,830
Initial investment	(1,484,100)	(1,641,573)	(1,764,812)
NPV	\)163,251	\(328,315	\)300,018

Short Answer

Step by step solution

Meaning of ARR

Computing the ARR for the investment

One App. One Place for Learning.

Most popular questions from this chapter

Recommended explanations on Business Studies Textbooks

Organizational Communication

Managerial Economics

Corporate Finance

Managers

Strategic Analysis

Financial Performance

Study anywhere. Anytime. Across all devices.