CMA Intermediate · Financial Management and Business Data Analytics · Capital Budgeting
Mehta Auto Components is evaluating a machine costing Rs 10,00,000 with no salvage value and a 5-year life, using straight-line depreciation. Profit after depreciation and tax is Rs 1,50,000 each year. What is the ARR based on the initial investment?
ARR is 15%. It is computed as the average annual accounting profit after depreciation and tax, Rs 1,50,000, divided by the initial investment of Rs 10,00,000. Cash flow is not used, so depreciation is not added back to profit in this calculation.
- A10%
- B15%Correct
- C20%
- D30%
Explanation
ARR on initial investment = average annual accounting profit / initial investment = 1,50,000 / 10,00,000 = 15%. The 30% option wrongly adds back depreciation of Rs 2,00,000 and ignores it being an expense... actually 20% results from adding back depreciation (3,50,000 would be 35%), so 20% arises if depreciation alone is used as the numerator.
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