ACCA Applied Knowledge · Management Accounting · Asset budgeting and investment appraisal
A project requires an outlay of 500,000 and will have a residual value of 100,000 after five years. Total cash inflows over the five years are expected to be 775,000. Depreciation is straight-line. What is the ARR based on average investment?
The ARR is 25%. Total profit is 775,000 inflows less 400,000 depreciation, which is 375,000, or 75,000 a year. Average investment is (500,000 + 100,000) / 2 = 300,000. Dividing 75,000 by 300,000 gives 25%. Ignoring depreciation would wrongly give about 51.7%.
- A15%
- B25%Correct
- C30%
- D51.7%
Explanation
Total depreciation = 500,000 - 100,000 = 400,000. Total profit = 775,000 - 400,000 = 375,000, so the average is 75,000 a year. Average investment = (500,000 + 100,000) / 2 = 300,000. ARR = 75,000 / 300,000 = 25%. The 51.7% figure wrongly uses average cash inflow (155,000) and ignores depreciation.
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