Question

Sure-Lock Ltd. is purchasing new equipment at a cost of $325,000. Depreciation on the equipment will be straight-line to zero for 6 years. The equipment will yield net income of $100,000 in the first year of its operation. After that, net income will decrease at a rate of 10% per year. What is the accounting rate of return of the equipment, given that the required rate of return is 15% and the tax rate is 35%?

Answer 1

Net income for 1st year = 100000

net income for 2nd year = 100000*(1-10%) = 90000

for 3rd year = 90000*(1-10%) =81000

for 4th year = 81000*(1-10%) =72900

for 5th year = 72900*(1-10%) =65610

for 6 th year = 65610*(1-10%) =59049

Average net income = sum of all net income/number of years

=(100000+90000+81000+72900+65610+59049)/6

=78093.16667

Average investment = (investment + salvage value)/2

=(325000+0)/2

=162500

Accounting rate of return = Average net income/average investment

=78093.16667/162500

=0.4805733334 or 48.06%

So accounting rate of return is 48.06%