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sir i got confused between the words in the question of section named as able ltd
in that its written additional revenue from project $120,000 per year and
and incrimental cost per year $30,000
for calculating net present value for the this what amount sould be considered
for reference i have typed whole question again
Able Ltd is considering a new project for which
the following information is available:
Initial cost – $300,000
Expected life – 5 years
Estimated scrap value – $20,000
Addition revenue from the project – $120,000
Incremental costs of the project – $30,000 per
Cost of capital – 10%
to consider cost for NPV and accounting rate of return what cost should be considered
and please confirm that accounting rate of return is same internal rate of return
No, the accounting rate of return is the average profit per year as a % of the average investment.
The average profit before depreciation is 120,000 – 30,000 = 90,000 per year.
The depreciation is (300,000 – 20,000) / 5 = 56,000
Therefore the profit after depreciation is 90,000 – 56,000 = 34,000 per year.
The average investment is (300,000 + 20,000) / 2 = 160,000
Therefore the ARR = 34,000/160,000 = 21.25%
As far as the NPV is concerned, the flows are as follows:
0 Initial cost (300,000)
1-5 net inflow. 90,000 per year
5 scrap proceeds. 20,000
The flows need discount at 10%
sir one thing, I know I am asking a dumb question but I am not getting it
what is the incremental cost of 30000 in this and why it got subtracted from average profit before depreciation when depreciation is 56000
tell me if i am correct or not incremental cost is subtracted from the average profit before depreciation just because its the additional cost incurred on the project
Incremental means extra, so they get extra revenue of 120,000 per year and have extra costs of 30,000 per year. Therefore there is a net extra profit (before depreciation) of 120,000 – 30,000 = 90,000 per year.