Calculation of Accounting Rate of Return: Equipment One costs $400,000 and is ex

Question

Calculation of Accounting Rate of Return: Equipment One costs $400,000 and is expected to yield an after-tax net income of $15,000 each year. Management predicts this machine has a 10-year service life and a $40,000 salvage value, and it uses straight-line depreciation. Part 1. Compute this machine's accounting rate of return for this proposed investment in equipment. You must show your work for credit. (1 point) Part 2. Assume the accounting rate of return for a similar investment in equipment (Equipment Two) for the same company was, say, 5.8%. Which investment (Equipment One or Equipment Two) would the company prefer AND why? (1 point)

Explanation / Answer

Accounting rate of return = average after tax net income / average investment

average after tax net income = 15000

average net investment = 400000 / 2 = 200000

Accounting rate of return = (15000/200000)*100 = 7.5%

Investment one would be preffered because it is having 7.5% rate of accounting return while project 2nd is having only 5.8%.

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