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