Example of accounting rate of return method, Finance Basics

Assignment Help:

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.


Related Discussions:- Example of accounting rate of return method

Weighted average cost of capital, Below is information provided for tw...

Below is information provided for two companies, A and B.  Assuming a risk-free rate of 2.5%, an effective tax rate of 40%, and a market risk premium of 5.5%, estimate th

Present value of a lump sum - dcf technique, Present Value of a Lump Sum - ...

Present Value of a Lump Sum - DCF Technique Generally an investor would want to know how much he or she would stop currently to get a provided amount in year 1, 2, ... n.  In

Cost of debentures, Do you guys provide Cost of Debentures assignment help....

Do you guys provide Cost of Debentures assignment help. I need writing a report on Cost of Debentures and it is about 2000 words. Let me know. I need to buy your solution.

Explain performance budgeting and zero base budgeting, Write short notes on...

Write short notes on the following: a) Performance budgeting b) Zero base budgeting c) Factors affecting dividend decisions d) Accrual concept

Public finance, models of solving externalities in 1) external sector 2)pr...

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

WACC., The following is the existing capital structure of Company XYZ Ltd. ...

The following is the existing capital structure of Company XYZ Ltd. Ordinary shares at Shs.10 par 1,000,000 Retained 800,000 12% preference shares Shs.10 par 400,000 16% loan Shs.1

Setting of optimal cash balance, Setting of Optimal Cash Balance Cash ...

Setting of Optimal Cash Balance Cash is often identified like a non-earning asset since holding cash quite than a revenue-generating asset includes a cost in form of foregone

Real Estate Finance - Real options valuation, I need to understand a practi...

I need to understand a practice question for exam, but I only have a partial solution. I need a more detailed solution, so can understand how to arrive at the answer. The problem

Differences between debt and preference share capital, Differences between ...

Differences between Debt and Preference Share Capital Differences between Debt and Preference Share Capital are given below:   DEBT

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd