Question

# WeCare Clinic is planning on investing in some new echocardiogram equipment that will require an initial...

WeCare Clinic is planning on investing in some new echocardiogram equipment that will require an initial outlay of \$170,000. The system has an expected life of five years and no expected salvage value. The investment is expected to produce the following net cash flows over its life: \$68,000, \$68,000, \$85,000, \$85,000, and \$102,000.

Required:

Calculate the annual net income for each of the five years.

Calculate the accounting rate of return.

What if a second competing revenue-producing investment has the same initial outlay and salvage value but the following cash flows (in chronological sequence): \$102,000, \$102,000, \$102,000, \$68,000, and \$17,000? Using the accounting rate of return metric, which project should be selected: the first or the second? Which project is really the better of the two?

 Answer 1) Calculate net income : Net income Year 1 68000-34000 = 34000 Year 2 68000-34000 = 34000 Year 3 85000-34000 = 51000 Year 4 85000-34000 = 51000 Year 5 102000-34000 = 68000 2) Accounting rate of return = Average net income*100/Average investment Average net income = 238000/5 = 47600 Average investment = 170000/2 = 85000 Accounting rate of return = 47600*100/85000= 56% 3) Calculate net income : Net income Year 1 102000-34000 = 68000 Year 2 102000-34000 = 68000 Year 3 102000-34000 = 68000 Year 4 68000-34000 = 34000 Year 5 17000-34000 = -17000 Accounting rate of return = Average net income*100/Average investment Average net income = 210000/5 = 42000 Average investment = 170000/2 = 85000 Accounting rate of return = 42000*100/85000= 49.41%

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