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Able Ltd is considering a new project, for with the following information is available:
Initial cost – $300,000
Expected life – 5years
Estimated scrap value – $20,000
Addition revenue from the project – $120,000 per year
Incremental costs of the project – $30,000 per year
Cost of capital – 10%Calculate the Accounting Rate of Return of the project (to the nearest %)
Dear Sir,
Please help to explain above question.
Thank you
The extra cash flow is 90,000 per year.
The average depreciation is (300,000 – 20,000) / 5 = 56,000 per year.
So the average profit is 90,000 – 56,000 = 34,000 per year.
The average investment is (300,0000 + 20,000) / 2 = 160,000.
So the ARR = 56,000/160,000 = 21.25%
(Have you watched my free lecture on investment appraisal?)
Dear Sir,
I would like to know that why added 20,000(scrap value) in average investment
The average investment is (300,0000 + 20,000) / 2 = 160,000.
It is the average value in the Statement of financial position (balance sheet).
If it cost 300,000 and had no scrap value, then the average value would be 300/2 = 150,000.
Here is costs 300,000 and has a value at the end of 20,000. The average of the two is 300+20/2 = 160,000.
(If you watch my lecture on investment appraisal then you will see I explain it there as well)
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