1) Dooney and Burke, is considering an investment in computer and network equipm
ID: 2372374 • Letter: 1
Question
1) Dooney and Burke, is considering an investment in computer
and network equipment costing $254,000. This equipment would allow
them to offer new programming services to clients. The equipment
will be depreciated on the straight-line basis over an eight-year
period with an estimated residual value of $60,000. Using the
accounting rate of return model, what is the minimum average annual
operating income that must be generated from this investment in
order to achieve 11% accounting rate of return?
2) When you graduated from college, your mother plans to give
you a gift of $50,000 to start you on your way. However, to
determine what you learned in business school, your mother presents
you with four options on how to received the gift. Which of the
options presented by your mother will yield the greatest present
value to you?
a) a lump sum of $50,000 after grad school (2 years) assuming a
3% discount rate?
b) a lump sum of $50,000 today
c) a lump sum of $50,000 after grad school (2 years) assuming a
5% discount rate
d) $25,000 per year for the next 2 years using a 3% discount
rate
Explanation / Answer
Definition of 'Accounting Rate of Return - ARR' The amount of profit, or return, that an individual can expect based on an investment made. Accounting rate of return divides the average profit by the initial investment in order to get the ratio or return that can be expected. This allows an investor or business owner to easily compare the profit potential for projects, products and investments. ARR is considered a straight-line method of gathering quantitative information. While this is a positive measure in some aspects, its lack of sophistication is also a drawback. ARR does not consider the time value of money, which means that returns taken in during later years may be worth less than those taken in now, and does not consider cash flows, which can be an integral part of maintaining a business. .................................................................................. Definition of 'Operating Profit' The profit earned from a firm's normal core business operations. This value does not include any profit earned from the firm's investments (such as earnings from firms in which the company has partial interest) and the effects of interest and taxes. Also known as "earnings before interest and tax" (EBIT). Calculated as: Operating Profit = Operating Revenue - COGS - Operating Expenses - Depreciation & Amortization Investopedia explains 'Operating Profit' For example, suppose ABC Printing Company earns $50 million from its core printing related operations, $10 million from its 40% stake in XYZ Corp. and $3.5 million from interest earned in its money market and bank accounts. In addition, the company spends $10 million in production related costs. Overall, the company's operating profit is $40 million. This is calculated as the $50 million in operating revenue million minus the $10 million in production costs. The other $10 million and $3.5 million in earnings are not included in operating income because they are investment income.
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