Landrum Corporation is considering investing in specialized equipment costing $250,000. The equipment has a useful life of 5 years and a residual value of $20,000. Depreciation is calculated using the straight-line method. The expected net cash inflows from the investment are:

Year 1 $60,000

Year 2 $90,000

Year 3 $110,000

Year 4 $40,000

Year 5 $25,000

Total cash inflows $325,000

Landrum Corporation's required rate of return on investments is 14%. What is the accounting rate of return on the investment?

A. 44.40%

B. 5.60%

C. 7.60%

D. 18.40%

Answer: ARR = Average profit/Initial outlay x 100

ARR = $19,000/$250,000 x 100

ARR = 7.60%

The correct answer is C

Depreciation = Cost - Residual value/Estimated useful life

= $250,000 - $20,000/5 years

= $46,000 per annum

Average profit = Total profit/No of years

= $325,000/5

= $65,000

$

Average profit 65,000

Less: Depreciation 46,000

Average profit after depreciation 19,000

Explanation: In determining the accounting rate of return of the investment, there is need to calculate depreciation using straight line method. The amount of depreciation would be deducted from the average profit so as to obtain the average profit after depreciation. The average profit would be divided by the initial outlay in order to obtain the accounting rate of return.