ACCA Applied Knowledge · Management Accounting · Asset budgeting and investment appraisal
Brook Co plans to buy equipment costing $500,000 with an expected residual value of $100,000 after 4 years. Total cash inflows over the 4 years are expected to be $700,000, and depreciation is straight-line. What is the ARR based on average investment?
The ARR is 25%. Total profit is $700,000 less $400,000 depreciation, which is $300,000, or $75,000 a year. Average investment is ($500,000 + $100,000)/2 = $300,000, so ARR is 75,000/300,000 = 25%. Using the initial investment gives 15%.
- A15%
- B25%Correct
- C30%
- D58.3%
Explanation
Total depreciation is 400,000, so total profit is 700,000 - 400,000 = 300,000, which is 75,000 a year. Average investment is (500,000 + 100,000)/2 = 300,000. ARR = 75,000/300,000 = 25%. The 15% figure wrongly uses initial investment, and 30% uses (500,000/2) as average investment, ignoring the residual value.
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