Question

You are deciding to start a delivery business in January 2020. The initial investment includes a small truck which costs $70,000. Other expenses were included in the expected cash flows. The truck has a useful life of 5 years and an estimated residual value at the end of the 5th year of $10,000 (the amount expected the truck can be sold). Depreciation is the only non-cash expense. The net cash flows of each year in the following 5 years are estimated as follows: Initial investment: $70,000 Net cash flow year 1: (20,000) Net cash flow year 2: 10,000 Net cash flow year 3: 20,000 Net cash flow year 4: 40,000 Net cash flow year 5: 30,000 Estimated sale of truck year 5: 10,000 Question 1: If your required rate of return is 8%, what would be your decision based on the accounting rate of return (ARR)? Total Depreciation = Average Profit Average investment = ARR = Decision? Why?

Answer 1

And > Total Depreciation fos 5 years Deprecation to initial investment - Calvage value por year = No of years Fos 5 yeag = } veco - 3 1сесо Буеаt g 5 years = 360,000 Total Depreciation = $60.000 > Average profit - Total profit forn yeary (6) no oo years Here total S-Actual profit = Total cash flow for 9. 5 years - Total Depreciation ! =f(29000)tique +29000 +60,000 + 3900 +10000] [60000] = $ 30000 Average profit = 30000 5 years Average profit - $6000

Average Investment - opening balance & closing balance = 70,000 + 19000 89000 ARR = = 40000 Accounting Rate of Return Aresage Net poefit Average Investment 6000 x 100% = 151. = *100%. 40000 PARR=15%. The project is acceptable Buying a trucks results is probet Because ARR 15%. is more than required rate to return.