Frank Co. has the opportunity to introduce a new product. Frank expects the product to sell for $60 and to have
per-unit variable costs of $35 and annual cash fixed costs of $4,000,000. Expected annual sales volume is 275,000
units. The equipment needed to bring out the new product costs $6,000,000, has a four-year life and no salvage
value, and would be depreciated on a straight-line basis. Frank’s cost of capital is 14% and its income tax rate is
40%.
Required: D, L & H 9E
a. Compute the annual net cash flows for the investment.
b. Compute the NPV of the project.
c. Suppose that some of the 275,000 units expected to be sold would be to customers who currently buy another
of Frank’s products, the X-10, which has a $12 per-unit contribution margin. Find the sales of X-10 that can
Frank lose per year and still have the investment in the new product return at least the 14% cost of capital.
d. Suppose that selling the new product has no complementary effects but that Frank’s production engineers
anticipate some production problems in making the new product and are not confident of the $35 estimate of
per-unit variable costs for the new product. Find the amount by which Frank’s estimate of per-unit variable cost
could be in error and the investment still have a return at least equal to the 14% cost of capital.
Net Cash Flow, NPV & IRR
297
. Acme is considering the purchase of a machine. Data are as follows:
Cost $160,000
Useful life 10 years
Annual straight-line depreciation $ ???
Expected annual savings in cash operation costs $ 33,000
Acme’s cutoff rate is 12% and its tax rate is 40%.
Required: D, L & H 9E
a. Compute the annual net cash flows for the investment.
b. Compute the NPV of the project.
c. Compute the IRR of the project.
Annual Cash Inflow, ARR, NPV, PI & IRR
298
. The Sun Corp. is contemplating the acquisition of an automatic car wash. The following information is relevant:
The cost of the car wash is $160,000
The anticipated revenue from the car wash is $100,000 per annum.
The useful life of the car wash is 10 years.
Annual operating costs are expected to be:
Salaries $30,000
Utilities 9,600
Water usage 4,400
Supplies 6,000
Repairs/maintenance 10,000
The firm uses straight-line depreciation.
The salvage value for the car wash is zero.
The company’s cutoff points are as follows:
Payback 3 years
Accounting rate of return 18%
Internal rate of return 18%
Ignore income taxes.
REQUIRED: Barfield
a. Compute the annual cash inflow.
b. Compute the net present value.
c. Compute internal rate of return.
d. Compute the payback period.
e. Compute the profitability index.
f. Should the car wash be purchased?
PROJECT EVALUATION & RANKING
299
. EIF Manufacturing Company needs to overhaul its drill press or buy a new one. The facts have been gathered,
and are as follows:
Current Machine New Machine
Purchase Price, New $80,000 $100,000
Current book value 30,000
Overhaul needed now 40,000
Annual cash operating costs 70,000 40,000
Current salvage value 20,000
Salvage value in five years 5,000 20,000
Required: (D) Horngren
Which alternative is the most desirable with a current required rate of return of 20%? Show computations, and
assume no taxes.
300
. Gavin and Alex, baseball consultants, are in need of a microcomputer network for their staff. They have received
three proposals, with related facts as follows:
Proposal A Proposal B Proposal C
Initial investment in equipment $90,000 $90,000 $90,000
Annual cash increase in operations:
Year 1 80,000 45,000 90,000
Year 2 10,000 45,000 0
Year 3 45,000 45,000 0
Salvage value 0 0 0
Estimated life 3 yrs 3 yrs 1 yr
The company uses straight-line depreciation for all capital assets.
Required: (D) Horngren
a. Compute the payback period, net present value, and accrual accounting rate of return with initial investment, for
each proposal. Use a required rate of return of 14%.
b. Rank each proposal 1, 2, and 3 using each method separately. Which proposal is best? Why?
301
. (Present value tables needed to answer this question.) The Ruth Company has been operating a small lunch
counter for the convenience of employees. The counter occupies space that is not needed for any other business
purpose. The lunch counter has been managed by a part-time employee whose annual salary is $3,000. Yearly
operations have consistently shown a loss as follows:
Receipts $20,000
Expenses for food, supplies (in cash) $19,000
Salary 3,000 22,000
Net Loss $(2,000)
A company has offered to sell Ruth automatic vending machines for a total cost of $12,000. Sales terms are cash on
delivery. The old equipment has zero disposal value.
The predicted useful life of the equipment is 10 years, with zero scrap value. The equipment will easily serve the
same volume that the lunch counter handled. Z catering company will completely service and supply the machines.
Prices and variety of food and drink will be the same as those that prevailed at the lunch counter. The catering
company will pay 5 percent of gross receipts to the Ruth Company and will bear all costs of food, repairs, and so
forth. The part-time employee will be discharged. Thus, Ruth’s only cost will be the initial outlay for the machines.
Consider only the two alternatives mentioned.
REQUIRED: Barfield
a. What is the annual income difference between alternatives?
b. Compute the payback period.
c. Compute:
- The net present value if relevant cost of capital is 20 percent.
- Internal rate of return.
d. Management is very uncertain about the prospective revenue from the vending equipment. Suppose that the
gross receipts amounted to $14,000 instead of $20,000. Repeat the computation in part c.1.
e. What would be the minimum amount of annual gross receipts from the vending equipment that would justify
making the investment? Show computations.
Payback, Net Present Value & Profitability Index
302
. (Present value tables needed to answer this question.) XYZ Co. is interested in purchasing a state-of-the-art widget
machine for its manufacturing plant. The new machine has been designed to basically eliminate all errors and
defects in the widget-making production process. The new machine will cost $150,000, and have a salvage value of
$70,000 at the end of its seven-year useful life. XYZ has determined that cash inflows for years 1 through 7 will be
as follows: $32,000; $57,000; $15,000; $28,000; $16,000; $10,000, and $15,000, respectively. Maintenance will be
required in years 3 and 6 at $10,000 and $7,000 respectively. XYZ uses a discount rate of 11 percent and wants
projects to have a payback period of no longer than five years.
REQUIRED: Barfield
a. Compute the net present value of the new machine.
b. Compute the firm’s profitability index.
c. Compute the payback period.
d. Evaluate this investment proposal for XYZ Co.
Point Of Indifference
303
. (Present value tables needed to answer this question.) Managers of the Jonathan Co. realize that the present value
of the depreciation tax benefit is affected by the discount rate, the tax rate, and the depreciation rate. They have
recently purchased a machine for $100,000 and they are trying to decide which depreciation method to use. There
are only two alternatives available, and they must make an irrevocable selection of one method or the other right
now. They have no uncertainty about the company’s discount rate (it is 10 percent), but they are highly uncertain
about the direction of future tax rates. The company’s uncertainty stems from the fact that the existing tax rate is 30
percent, but congress is presently debating tax legislation that would dramatically increase the rate. If the legislation
is passed it would go into affect in two years (after the Jonathan Co. has claimed two years of depreciation).
Method 1 Method 2 Difference
Year 1 $30,000 $10,000 $(20,000)
Year 2 $40,000 $15,000 $(25,000)
Year 3 $10,000 $25,000 $ 15,000
Year 4 $10,000 $25,000 $ 15,000
Year 5 $10,000 $25,000 $ 15,000
REQUIRED: Barfield
How high would tax rates need to be in two years for the Jonathan Co. to be indifferent between depreciation
Method 2 and depreciation Method 1 below?
.
304
. XL Corp. is considering an investment that will require an initial cash outlay of $200,000 to purchase nondepreciable assets. The project promises to return $60,000 per year (after-tax) for eight years with no salvage value.
The company’s cost of capital is 11 percent.
(Present value tables needed to answer this question.) The company is uncertain about its estimate of the life
expectancy of the project.
REQUIRED: Barfield
How many years must the project generate the $60,000 per year return for the company to at least be indifferent
about its acceptance? (Do not consider the possibility of partial year returns.) Barfield
INFLATION
Effect of Inflation on Investment Decision
305
. Ranchero Company is evaluating a capital budgeting proposal that will require an initial cash investment of
$100,000. The project will have a 3-year life. The net after-tax cash inflows from the project, before any adjustment
for the effects of inflation, are expected to be as follows:
Year Unadjusted Estimate of Cash Inflows
1 $50,000
2 40,000
3 30,000
No salvage is expected at the end of the project. The anticipated inflation rate is 10% each year. The company’s
cost of capital rate is 16%.
Required: Carter & Usry
(1) Compute the estimated cash inflow for each year, adjusted for the anticipated effect of inflation.
(2) Determine the net present value of the cash flows before and after the adjustment for the anticipated effects of
inflation.
(The present values of $1 @ 16% at the end of years 1, 2, and 3 respectively are .862, .743, and .641. The present
value of an annuity of $1 @ 16% for 3 years is 2.246.)
Estimating Pretax Cash Inflows With Inflation
306
. Speedi Corporation is considering a capital expenditure proposal which will require an initial cash outlay of $50,000.
The project life is expected to be 6 years. The estimated salvage value for the equipment (based on today’s market
price for similar used 6-year old equipment) is $2,500. Estimated annual net cash inflows from operations during
the life of the project follow:
Year Estimated Annual Cash Inflow
1 $10,000
2 15,000
3 15,000
4 15,000
5 10,000
6 5,000
Required: Carter & Usry
Compute the excess of cash inflows over cash outflows assuming management expects a constant 4% rate of
inflation during the 6-year period. (Round your price level index to three decimal places.)
Effect of Inflation and Taxes on Investment Decision
307
. Weighout Company is evaluating a capital expenditure proposal that will require an initial cash investment of
$100,000. The project will have a 6-year life; however, the property will qualify as 5-year property for income-tax
depreciation purposes. The income tax rate is 40%. The annual cash inflows from the project, before any
adjustment for the effects of inflation or income taxes, are expected to be as follows:
Year Unadjusted Estimate of Cash Inflows
1 $25,000
2 27,000
3 29,000
4 23,000
5 20,000
6 15,000
The expected salvage value of the property is zero. Cash inflows are expected to increase at the anticipated
inflation rate of 4% each year.
Required: Carter & Usry
Compute the inflation adjusted after-tax cash inflow from the proposal for each year, and the excess of total net
cash inflows over the initial cash outlay. (Use the MACRS depreciation rates provided below to compute tax
depreciation, and round the price-level index to three decimal places.)
Year MACRS 5-year Recovery Rate
1 0.200
2 0.320
3 0.192
4 0.115
5 0.115
6 0.058
1.000
COST OF CAPITAL
308
. Molloy Company wishes to compute a weighted-average cost of capital for use in evaluating capital expenditure
proposals. Earnings, capital structure, and current market prices of the company’s securities are:
Earnings:
Earnings before interest and tax $400,000
Interest expense on bonds 100,000
Pretax earnings $300,000
Income tax (40%) 120,000
Aftertax earnings $180,000
Preferred stock dividends 75,000
Earnings available to common stockholders $105,000
Common stock dividends 50,000
Retained earnings $ 55,000
Capital structure:
Mortgage bonds, 12%, 20 years $500,000
Preferred stock, 15%, $100 par 500,000
Common stock, no par, 25,000 shares 300,000
Retained earnings (equity of common stockholders) 700,000
$ 2,000,000
Market price of the company’s securities:
Preferred stock $100
Common stock 30
Required: Carter & Usry
Determine the company’s cost of capital to the nearest hundredth of a percent.
1 . ($85,000 – 54,500) = $30,500 – $25,000 = $5,500 loss x 0.4 = $2,200 tax savings from loss plus $25,000
proceeds = $27,200.
2 . Taxes = ($12,000 – $4,000) x 0.40 = $3,200
Cash flow = $12,000 – $3,200 = $8,800
3 . Answer (C) is correct. The old machine has a book value of $10,000 [$15,000 cost – 5($15,000 cost ÷ 15 years)
depreciation]. The loss on the sale is $4,000 ($10,000 – $6,000 cash received), and the tax savings from the loss is
$1,600 (40% x $4,000). Thus, total inflows are $7,600. The only outflow is the $25,000 purchase price of the new
machine. The net cash investment is therefore $17,400 ($25,000 – $7,600).
Answer (A) is incorrect because $19,000 overlooks the tax savings from the loss on the old machine. Answer (B) is
incorrect because $15,000 is obtained by deducting the old book value from the purchase price. Answer (D) is
incorrect because the net investment is less than $25,000 given sales proceeds from the old machine and the tax
savings.
4
Cost of new machine
$75,000
Less: After-tax inflow from old machine ($10,000 x .60)
6,000
$69,000
5 . Answer (C) is correct. The amount of the after-tax cash operating savings is $90,000 [$150,000 pretax savings
x (1.0 – .40)]. The proceeds from sale of existing equipment are given as $100,000. The tax benefit from sale of
existing equipment is $104,000 [($360,000 carrying amount – $100,000 proceeds) x 40% tax rate].
Answer (A) is incorrect because the sale of existing equipment will result in a loss that will produce a $104,000 tax
benefit. Answer (B) is incorrect because $60,000 is the tax on the $150,000 of net profit arising from the $150,000
cost savings. Also, the $100,000 of proceeds from the equipment sale should not be reduced by the 40% tax rate to
$60,000. Answer (D) is incorrect because $60,000 is the tax on the $150,000 of net income arising from the
$150,000 cost savings. Also, $40,000 equals the tax on $100,000, and $156,000 equals 60% of $260,000.
6
Cost of new machine
$75,000
Less: Trade-in allowance
10,000
$65,000
7 . Answer (C) is correct. The investment required includes increases in working capital (e.g., additional
receivables and inventories resulting from the acquisition of a new manufacturing plant). The additional working
capital is an initial cost of the investment, but one that will be recovered (i.e., it has a salvage value equal to its initial
cost). Lawson can use current liabilities to fund assets to the extent of 10% of sales. Thus, the total initial cash
outlay will be $4.6 million {$4 million + [(30% – 10%) x $3 million sales]}.
Answer (A) is incorrect because $3.4 million deducts the investment in working capital from the cost of equipment.
Answer (B) is incorrect because $4.3 million equals $4 million plus 10% of $3 million. Answer (D) is incorrect
because $4.9 million fails to consider the financing of 33-1/3% of the incremental current assets with accounts
payable.
8 . Answer (C) is correct. For capital budgeting purposes, the net investment is the net outlay or cash requirement.
This amount includes the cost of the new equipment, minus any cash recovered from the trade or sale of existing
assets. The investment required also includes funds to provide for increases in working capital, for example, the
additional receivables and inventories resulting from the acquisition of a new manufacturing plant. The investment in
working capital is treated as an initial cost of the investment, although it will be recovered at the end of the project
(its salvage value equals its initial cost). For Kline, the additional current assets will be 30% of sales, but current
liabilities can be used to fund assets to the extent of 10% of sales. Thus, the initial investment in working capital will
equal 20% of the $6 million in sales, or $1,200,000. The total initial cash outlay will consist of the $8 million in new
equipment plus $1,200,000 in working capital, a total of $9.2 million.
Answer (A) is incorrect because $6.8 million subtracted the net investment in working capital from the cost of the
equipment. Answer (B) is incorrect because $8.6 million assumes current assets will increase by 10% of new sales
but that current liabilities will not change. Answer (D) is incorrect because $9.8 million ignores the financing of
incremental current assets with accounts payable.
9 . ($40,000 – $30,000) x 0.40 = $4,000
10 . Answer (A) is correct. The concept of present value gives greater value to inflows received earlier in the stream.
Thus, the declining inflows would be superior to increasing inflows, or even inflows.
Answer (B) is incorrect because it involves lower inflows in the earlier years. Answer (C) is incorrect because it
involves lower inflows in the earlier years. Answer (D) is incorrect because it involves lower inflows in the earlier
years.
11 . Answer (C) is correct. The increase in pre-tax net profit is 140,000 (400,000 cash sales increase – 180,000
nondepreciation expenses increase – 80,000 depreciation). Thus, taxes will increase by 47,600 (34% x 140,000),
and the increase in net cash inflows will be 172,400 (400,000 – 180,000 – 47,600).
Answer (A) is incorrect because 92,400 equals the increase in after-tax net profit. Answer (B) is incorrect because
140,000 is the increase in pre-tax net profit. Answer (D) is incorrect because 220,000 equals cash sales minus
expenses other than depreciation.
12 . Answer (D) is correct. Depreciation expense is not a cash outflow and is not considered in the cash analysis
except for its effects on taxes paid. Thus, the expected annual cash flow is $14,000 {(1.0 – .4 tax rate)[$50,000 cash
sales – $10,000 fixed cost – (.4 x $50,000) variable costs – $5,000 depreciation] + $5,000 depreciation}.
Answer (A) is incorrect because $15,000 is the pre-tax income from the project. Answer (B) is incorrect because
$9,000 includes depreciation as a cash outflow. Answer (C) is incorrect because $19,000 equals expected annual
cash flow plus depreciation.
13 . $50,000 x 5 = $250,000 x (1- 0.4) = $150,000 net cash flow
14 . Answer (B) is correct. The project will have an $11,000 before-tax cash inflow from operations in the tenth year
($40,000 – $29,000). Also, $9,000 will be generated from the sale of the equipment. The entire $9,000 will be
taxable because the basis of the asset was reduced to zero in the 7th year. Thus, taxable income will be $20,000
($11,000 + $9,000), leaving a net after-tax cash inflow of $12,000 [(1.0 – .4) x $20,000]. To this $12,000 must be
added the $12,000 tied up in working capital ($7,000 + $5,000). The total net cash flow in the 10th year will
therefore be $24,000.
Answer (A) is incorrect because $32,000 omits the $8,000 outflow for income taxes. Answer (C) is incorrect
because taxes will be $8,000, not $12,000. Answer (D) is incorrect because $11,000 is the net operating cash flow.
15 . Answer (C) is correct. The tax basis of $75,000 and the $40,000 cost to remove can be written off. However,
the $10,000 scrap value is a cash inflow. Thus, the taxable loss is $105,000 ($75,000 loss on disposal + $40,000
expense to remove – $10,000 of inflows). At a 40% tax rate, the $105,000 loss will produce a tax savings (inflow) of
$42,000. The final cash flows will consist of an outflow of $40,000 (cost to remove) and inflows of $10,000 (scrap)
and $42,000 (tax savings), or a net inflow of $12,000.
Answer (A) is incorrect because $45,000 ignores income taxes and assumes that the loss on disposal involves a
cash inflow. Answer (B) is incorrect because $27,000 assumes that the loss on disposal involves a cash inflow.
Answer (D) is incorrect because $(18,000) ignores the tax loss on disposal.
16 . Answer (C) is correct. The tax basis of $150,000 and the $80,000 cost to remove are deductible expenses, but
the $20,000 scrap value is an offsetting cash inflow. Thus, the taxable loss is $210,000 ($150,000 + $80,000 –
$20,000). At a 40% tax rate, the $210,000 loss will produce a tax savings (inflow) of $84,000. Accordingly, the final
cash flows will consist of an outflow of $80,000 (cost to remove) and inflows of $20,000 (scrap) and $84,000 (tax
savings), a net inflow of $24,000.
Answer (A) is incorrect because $90,000 assumes that the loss on disposal is a cash inflow. It also ignores income
taxes. Answer (B) is incorrect because $54,000 assumes that the loss on disposal involves a cash inflow. Answer
(D) is incorrect because $(36,000) assumes that the tax basis is $0.
17 . $50,000 x 40% = $20,000
18 . $80,000 x 40% = $32,000
19
Additional depreciation on the new machine
$(40,000)
Loss on sale of old machine
(45,000)
Operating cost savings
125,000
Increase in income
$ 40,000
20 . (A) ($8,000 x .97087) + ($12,000 x .94260) + ($10,000 x .91514) + ($15,000 x .88849) =
$7,767 + 11,311 + 9,151 + 13,327 = $41,556
21 . $27,000 x 0.641 (PVIF, n = 3, 16%) = $17,307
22 . $6,000 x 0.404 (PVIF, n = 8, 12%) = $2,424
23.
Revenues
$48,100
Less: Variable costs
(16,000)
Fixed out-of-pocket costs
(10,000)
Annual cash inflows
$22,000
PVAF, n = 8, 12%
x 4.968
Present value
$109,296
24 . Answer (D) is correct. Initially, the company must invest $105,000 in the machine, consisting of the invoice price
of $90,000, the delivery costs of $6,000, and the installation costs of $9,000.
Answer (A) is incorrect because $(85,000) erroneously includes salvage value but ignores delivery and installation
costs. Answer (B) is incorrect because $(90,000) ignores the outlays needed for delivery and installation costs, both
of which are an integral part of preparing the new asset for use. Answer (C) is incorrect because $(96,000) fails to
include installation costs in the total.
25 . Answer (A) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price – $450 of
variable costs), or a total of $100,000 per year. This amount will be subject to taxation, but, for the first 5 years, there
will be a depreciation deduction of $21,000 per year ($105,000 cost divided by 5 years). Therefore, deducting the
$21,000 of depreciation expense from the $100,000 of contribution margin will result in taxable income of $79,000.
After income taxes of $31,600 ($79,000 x 40%), the net cash flow in the third year is $68,400 ($100,000 – $31,600).
Answer (B) is incorrect because $68,000 deducts salvage value when calculating depreciation expense, which is not
required by the tax law. Answer (C) is incorrect because $64,200 assumes depreciation is deducted for tax
purposes over 10 years rather than 5 years. Answer (D) is incorrect because $79,000 is taxable income.
26 . Answer (D) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price – $450 of
variable costs), or a total of $100,000 per year. This amount will be subject to taxation, as will the $5,000 gain on
sale of the investment, bringing taxable income to $105,000. No depreciation will be deducted in the tenth year
because the asset was fully depreciated after 5 years. Because the asset was fully depreciated (book value was
zero), the $5,000 salvage value received would be fully taxable. After income taxes of $42,000 ($105,000 x 40%),
the net cash flow in the tenth year is $63,000 ($105,000 – $42,000).
Answer (A) is incorrect because $100,000 overlooks the salvage proceeds and the taxes to be paid. Answer (B) is
incorrect because $81,000 miscalculates income taxes. Answer (C) is incorrect because $68,400 assumes that
depreciation is deducted; it also overlooks the receipt of the salvage proceeds.
27 . Answer (D) is correct. Delivery and installation costs are essential to preparing the machine for its intended use.
Thus, the company must initially pay $210,000 for the machine, consisting of the invoice price of $180,000, the
delivery costs of $12,000, and the $18,000 of installation costs.
Answer (A) is incorrect because $(170,000) includes salvage value and ignores delivery and installation costs.
Answer (B) is incorrect because $(180,000) ignores the outlays needed for delivery and installation. Answer (C) is
incorrect because $(192,000) excludes installation costs.
28 . Answer (A) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price – $450
variable costs), a total of $200,000 per year for 4,000 units. This amount will be subject to taxation. However, for the
first 5 years, a depreciation deduction of $42,000 per year ($210,000 cost ÷ 5 years) will be available. Thus, annual
taxable income will be $158,000 ($200,000 – $42,000). At a 40% tax rate, income tax expense will be $63,200, and
the net cash inflow will be $136,800 ($200,000 – $63,200).
Answer (B) is incorrect because $136,000 results from subtracting salvage value when calculating depreciation
expense. Answer (C) is incorrect because $128,400 assumes depreciation is recognized over 10 years. Answer
(D) is incorrect because $107,400 assumes that depreciation is recognized over 10 years and that it requires a cash
outlay.
29 . Answer (D) is correct. The company will receive net cash inflows of $50 per unit ($500 selling price – $450 of
variable costs), a total of $200,000 per year for 4,000 units. This amount will be subject to taxation, as will the
$10,000 gain on sale of the investment, resulting in taxable income of $210,000. No depreciation will be deducted in
the tenth year because the asset was fully depreciated after 5 years. Because the asset was fully depreciated (book
value was $0), the $10,000 received as salvage value is fully taxable. At 40%, the tax on $210,000 is $84,000. After
subtracting $84,000 of tax expense from the $210,000 of inflows, the net inflows amount to $126,000.
Answer (A) is incorrect because $200,000 overlooks the salvage proceeds and the taxes to be paid. Answer (B) is
incorrect because $158,000 equals annual taxable income for each of the first 5 years. Answer (C) is incorrect
because $136,800 is the annual net cash inflow in the second through the fifth years.
30 . Answer (B) is correct. When annual cash inflows are uniform, the payback period is calculated by dividing the
initial investment ($210,000) by the annual net cash inflows ($136,800). Dividing $210,000 by $136,800 produces a
payback period of 1.54 years.
Answer (A) is incorrect because 1.05 years fails to subtract income taxes. Answer (C) is incorrect because 1.33
years includes taxable income in the denominator instead of cash flows. Answer (D) is incorrect because 2.22 years
subtracts depreciation from cash flows.
31 . Answer (C) is correct. The accounting rate of return method (ARR) computes an approximate rate of return
which ignores the time value of money. It is computed as follows:
ARR = expected increase in net income Average investment.
Therefore, $40,000 (as stated in problem) is the expected increase in annual income.
32 . [$16,000 – ($80,000/8)]/$80,000 = 7.5%
33 . {$12,000 – [($30,000 – $3,000)/5)]}/$30,000 = 22%
34 . Net Income After Tax (P280,000 x 20%) P 56,000
Divide by (1 – 0.30) 0.70
Net Income before Tax P 80,000
Add Depreciation 35,000
Cash Flow before Tax P115,00
