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ACCA Applied Knowledge · Management Accounting · Asset budgeting and investment appraisal

Delta Co requires a minimum ARR of 16% based on average investment. A project costs $300,000, has no residual value and lasts 6 years with straight-line depreciation. What is the minimum constant annual cash inflow needed to meet the target?

The minimum annual cash inflow is $74,000. Average investment is $150,000, so 16% requires an annual profit of $24,000. Depreciation of $50,000 a year must be added back to turn that accounting profit into the cash inflow needed.

  1. A$24,000
  2. B$74,000Correct
  3. C$98,000
  4. D$124,000

Explanation

Average investment is 300,000/2 = 150,000, so required annual profit is 16% × 150,000 = 24,000. Annual depreciation is 300,000/6 = 50,000. Required cash inflow = 24,000 + 50,000 = 74,000. The 24,000 figure forgets to add back depreciation, and 98,000 comes from applying 16% to the initial investment (48,000 + 50,000).

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