Accounting Rate of Return Coffee-K Group operates a chain of coffee shops. The c

Question

Accounting Rate of Return

Coffee-K Group operates a chain of coffee shops. The company is considering two possible expansion plans. Plan A would involve opening ten smaller shops at a cost of $8,570,000. Expected annual net cash inflows are $1,550,000, with zero residual value at the end of nine years. Under Plan B, Coffee-K would open four larger shops at a cost of $8,010,000. This plan is expected to generate net cash inflows of $1,050,000 per year for nine years, the estimated life of the properties. Estimated residual value for Plan B is $1,075,000. Coffee-K Group uses straight-line depreciation and requires an annual rate of return of 6%.

1. Compute accounting rate of return (round answers to one decimal place):

a. Compute accounting rate of return for Plan A:

b. Compute accounting rate of return for Plan B:

2. Enter as a positive if positive NPV and negative if negative NPV.

a. Compute net present value for Plan A (round answer to the nearest dollar):

b. Compute net present value for Plan B (round answer to the nearest dollar):

Explanation / Answer

There are 2 questions, I am answering only one question.

1.

Accounting rate of Return = Average annual accounting profit / Initial investment

(a) Accounting rate of return for Plan A

Initial investment = $8570000

Annual depreciation = $8570000 / 9 = $952222.22

Average annual accounting profit = $1550000 – $952222.22 = $597777.78

Accounting rate of return = $597777.78 / $8570000 = 6.97%

(b) Accounting rate of return for Plan B

Initial investment = $8010000

Annual depreciation = $8010000 – $1075000 / 9 = $770555.55

Average annual accounting profit = $1,050,000 – $770555.55 = $279444.45

Accounting rate of return = $279444.45 / $8010000 = 3.49%

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