Aqua Shop is considering the purchase of a used printing press costing $15,000. The printing press would generate a net cash inflow of $6,000 per year for four years. At the end of four years, the press would have no salvage value. The company's cost of capital is 12%. The company uses straight-line depreciation with no mid-year convention. What is the accounting rate of return on the original investment in the press to the nearest percent, assuming no taxes are paid?

a. 20 % b. 15% c. 41% d. 9%

The answer is: b

Explanation:

The accounting rate of return (ARR) is used to evaluate the profitability of an investment. It is the average net income that an asset is expected to generate expressed as a percentage of the average capital cost incurred. The ARR is computed as follows:

ARR = average annual profit / Average investment

Where:

Average annual profit = Total profit over investment period / number of years

Average investment = Book value of investment at year 1 / Book value of investment at the end of the useful life

Profit per year = Net cash inflow less depreciation of the printing press

= $6, 000 - ($15, 000/4)

= $6, 000 - $3, 750

= $2, 250

Average investment = $ 15, 000 (investment has no salvage value at the end of it useful life)

ARR = $2, 250 / $15, 000

= 15%

The ARR is greater than the cost of capital of 12%. Therefore, holding all other factors constant, Aqua shop should buy the used printing press as it would generate an additional profit of 3 cents for every dollar spent to acquire it.

B. 15%