Question

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

Answer |
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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% |

Accounting Rate of
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