Example of accounting rate of return method, Finance Basics

Example of Accounting Rate of Return Method

                                   Shs.

Project X cost              500,000

Scrap value                 100,000

Stream of income before when depreciation and taxes are follows as:

                         Shs.

Year 1              100,000

Year 2              120,000

Year 3              140,000

Year 4              160,000

Year 5              200,000

Let tax = 50% and depreciation straight line. Compute the accounting rate of return.

Solution

Depreciation   =          (500,000 - 100,000)/ 5 years

                     =          Shs.80, 000

Year

1

2

3

4

5

Income

Less depreciation

Earnings before tax EBT

Less tax @ 50%

EAT

100,000

  80,000

20,000

(10,000)

10,000

120,000

  80,000

40,000

(20,000)

20,000

140,000

  80,000

50,000

(30,000)

30,000

160,000

  80,000

80,000

(40,000)

40,000

200,000

  80,000

120,000

(60,000)

60,000

Average income (EAT)   = 32,000

Average investment       = (500,000 + 100,000) ½   =          300,000

Or ARR = (Average income / Average investment) x 100 =  32,000 /300,000 x 100 = 10.67%

Note   

The method of depreciation to use should be that which will generate larger depreciation alterations in the 1st few years of the assets life and lesser changes in the later years since this will generate a higher tax shield to the company along with higher value of inflows.  So reducing balance is preferred as compared to sum of digits and straight line method.

Posted Date: 1/30/2013 5:09:46 AM | Location : United States







Related Discussions:- Example of accounting rate of return method, Assignment Help, Ask Question on Example of accounting rate of return method, Get Answer, Expert's Help, Example of accounting rate of return method Discussions

Write discussion on Example of accounting rate of return method
Your posts are moderated
Related Questions
Access to Capital Markets and Ownership Structure  Ownership Structure A dividend policy may be driven with Time Ownership Structure as like in small firms whereas manage

I need help with : an introduction to financial markets and institutions , 2 edition , brown, nesiba, burton

A Ltd.'s share gives a return of 20% and B Ltd.'s share gives 32% return. Mr. Gotha invested 25% in A Ltd.'s share and 75% of B Ltd.'s shares. What would be the expected return of

models of solving externalities in 1) external sector 2)private sector

Illustrate in brief about the Investment  Process A  typical  investment  decision  undergoes  a  five  step  procedure which, in turn, forms the foundation of investment pr

Oogenesis - Gametogenesis The maturing procedure in oogenesis leading to the formation of ovum begins before birth but is not completed until after puberty. The primary oocyte

Application of Discriminant Analysis Application of Discriminant Analysis to the Selection of Applicants, Discriminative analysis is a statistical model such can be used to ac

A paper mill produces two grades of paper viz., X and Y. Because of raw material restrictions, it cannot produce more than 400 tons of grade X paper and 300 tons of grade Y paper i

As the Chief Financial Officer for the wholly Australian owned, Australian Stock Exchange listed company, Toy Show Ltd., an importer and manufacturer of a range of quality children

Shareholders Expectation and Growth Stage Growth Stage Dividend policy is likely to be influenced with firm's growth stage as like a young rapidly growing firm is probabl