Question

Caruso Hardware is adding a new product line that will require an investment of $1,460,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of $320,000 the first year, $290,000 the second year, and $260,000 each year thereafter for eight years. The investment has no residual value. Compute the ARR for the investment.

Answer #1

Annua depreciation = (cost - residual value) / life of the assets

= ($1,460,000 - 0)10

= $146,000

Year |
Cash Infows |
Less: Depreciation |
Net profit |

1 | $320,000 | $146,000 | $174,000 |

2 | $290,000 | $146,000 | $144,000 |

3 | $260,000 | $146,000 | $114,000 |

4 | $260,000 | $146,000 | $114,000 |

5 | $260,000 | $146,000 | $114,000 |

6 | $260,000 | $146,000 | $114,000 |

7 | $260,000 | $146,000 | $114,000 |

8 | $260,000 | $146,000 | $114,000 |

9 | $260,000 | $146,000 | $114,000 |

10 | $260,000 | $146,000 | $114,000 |

Tota profit | $1,230,000 | ||

Average net profit ($1,230,000/10 years) | $123,000 |

ARR = Average net profit / Average investment

= $123,000 / [($1460000+0)/2]

= 16.85%

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