ACCOUNTING RATE OF RETURN Each of the following scenarios is independent. Assume that all cash flows are after-tax cash flows.

a. Nomander Company is considering the purchase of new equipment that will speed up the process for extracting copper. The equipment will cost $2,400,000 and have a life of five years with no expected salvage value. The expected cash flows associated with the project are as follows:

Year Cash Revenues Cash Expenses 1 $4,000,000 $3,200,000 2 4,000,000 3,200,000 3 4,000,000 3,200,000 4 4,000,000 3,200,000 5 4,000,000 3,200,000

b. Marlene Straithe is considering investing in one of the following two projects.

Either project will require an investment of $30,000. The expected revenues less cash expenses for the two projects follow. Assume each project is depreciable.

Year Project A Project B 1 $ 9,000 $ 9,000 2 12,000 12,000 3 15,000 18,000 4 30,000 9,000 5 30,000 9,000

c. Suppose that a project has an accounting rate of return of 40 percent (based on initial investment) and that the average net income of the project is $160,000.

d. Suppose that a project has an accounting rate of return of 25 percent and that the investment is $100,000.

Required:

. Compute the ARR on the new equipment that Nomander Company is considering.

. Which project should Marlene Straithe choose based on the ARR?

. How much did the company in scenario

(c) invest in the project?

. What is the average income earned by the project in scenario (d)?

Exercise