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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?

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Answer #1
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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