Question
Herts & Co Ltd is considering a project to purchase a travel agency, for which the initial outlay would cost £ 200,000 , where scrap value is zero. Herts & Co Ltd's cost of capital is currently 12 % . Discount Factors at 12 % Year 1 & 0.893 Year 2 & 0.797 Year 3 & 0.712 Year 4. & 0.636 Year 5 & 0.567 The anticipated cash inflows and profits over the next 5 years are forecast as follows: Years & Cashflows £ & Profit £ 1 & 65,000 & 55,000 2 & 75,000 & 65,000 3 & 70,000 & 60,000 4 & 60,000 & 50,000 5 & 48,000 & 38,000 Using the formula for ARR below, which of the following options is the correct answer for ARR (Accounting rate of return)? - ARR = Average annual profit times 100 %
Answer
4
(153 Votes)
Skye
Professional · Tutor for 6 years
Answer
## Step1:Sum of annual net profits:
## Step2:The average annual profit,
## Step3 and 4: Substitute the given values to the formula of ARR:Substituting values into the formula give: ARR
The Accounting Rate of Return (ARR) for the project is **26.8%**.
Explanation
## Step1: The first step in computing the Accounting Rate of Return is to calculate the average annual profit. From the provided data, the annual net profits are given:
,
,
,
, and
for years 1 through 5 respectively. ## Step2: We now find the average profit by adding up all the annual net profits and divide by the number of years. ## Step3: Next, we use the formula for ARR. The ARR is computed by dividing the average annual profit by the initial investment and then changes that number into percentage form. ## Step4: The second part of the ARR formula specifies that initial investment is £200,000. # LaTeX formatting:### The formula for average annual profit:
### The formula Accounting Rate of Return is :