MBATech, Inc., is negotiating with the mayor of Bean City to start a manufacturi

Question

MBATech, Inc., is negotiating with the mayor of Bean City to start a manufacturing plant in an
abandoned building. The cash flows for MBAT’s proposed plant are:
Year 0 Year 1 Year 2 Year 3 Year 4
- 1,000,000 371,739 371,739 371,739 371,739
The city has agreed to subsidize MBAT. The form and timing of the subsidy have not been
determined, and depend on which investment criterion is used by MBAT. In preliminary discussions,
MBAT suggested four alternatives:
[A] Subsidize the project to bring its IRR to 25%.
[B] Subsidize the project to provide a two-year payback.
[C] Subsidize the project to provide an NPV of $75,000 when cash flows are discounted at 20%.
[D] Subsidize the project to provide an accounting rate of return (ARR) of 40%.

how do you compute part D?

Explanation / Answer

Part (D)

Accounting rate of return=Average accounting profit/ Average investment 40%=371739/Average investment Average investment=371739/40%= $ 929348 Subsidy required=1000000-929348=$70,652

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