Robinson Hardware is adding a new product line that will require an investment of $1,500,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of $320,000 the first year, $265,000 the second year, and $230,000 each year thereafter for eight years. The investment has no residual value. Compute the ARR for the investment.
First, enter the formula, then compute the ARR of the new product line.
Solution:
Annual depreciation = $1,500,000 / 10 = $150,000
Average annual cash inflows = ($320,000 + $265,000 + $230,000*8) / 10 = $242,500
Average annual income = $242,500 - $150,000 = $92,500
Average investment = (Cost + Residual value) / 2 = ($1,500,000 +0)/2 = $750,000
ARR = Average annual income / Average investment = $92,500 / $750,000 = 12.33%
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