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
Concentration Banking Firms along with regional sales outlets can designate specific of these as regional collection centre. Customers during these areas are necessitated to r


Growth Rates Most Recent Fiscal Year Fiscal Year (-1) Fiscal Year (-2) Fiscal Year (-3) Annu

What does it mean to say that individuals as a group are net suppliers of funds for financial institutions? What do you think the consequences might be in financial markets if indi

Sole Proprietorship Definition - A sole proprietorship or sole tradership is the oldest and simplest form of business. It is that type of business organization where one person

Solution to the Agency Conflict The government can acquire the following actions to protect itself and its interests. 1. Acquire monitoring costs E.g. the gover

Advantage of Joint Stock Companies The company can own assets and incur liabilities on its own accord. Perpetual existence as or going to relate that allows the compan

Price Earnings Ratio Price earnings (P/E) or ratio =  Market price per share (MPS)/Earnings per share                                     OR    = Market value of equity /Ea

XYZ Ltd. has an average selling price of Rs.10 per unit. Its variable cost are Rs.7 , and fixed cost amount to Rs.170000. it finances all its assets by equity funds. It pays 35% ta

Risk Adjusted Discounting Rate - Methods of Computing Cost of Capital This method is used to establish the discounting rate to be used for a provided project. The cost of capi