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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Orlin plc invests $500,000 in a machine with a residual value of $50,000 after five years. Total accounting profits before depreciation over the five years are $450,000, and depreciation is straight line. The company calculates ARR as average annual accounting profit divided by average investment, where average investment is (initial investment + residual value)/2. What is the ARR?

The ARR is zero. Depreciation over five years is $450,000 (cost less residual value), which exactly equals the $450,000 of profit before depreciation. Average annual accounting profit is therefore nil, so the return on the average investment is 0%.

  1. AZeroCorrect
  2. B18.0%
  3. C32.7%
  4. D36.0%

Explanation

Total depreciation is $450,000 (500,000 - 50,000), so total accounting profit over five years is 450,000 - 450,000 = 0. Average annual profit is zero, giving an ARR of zero. Choosing 18% or 36% results from ignoring depreciation (profit $90,000 divided by $500,000 gives 18%; divided by $250,000 gives 36%).

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