A company is planning to purchase a machine that will cost $25,200 with a six-year life and no salvage value. The company expects to sell the machine's output of 3,000 units evenly throughout each year. A projected income statement for each year of the asset's life appears below. What is the accounting rate of return for this machine

Net annual average profit

= Net cashflow - Depreciation

= $6,000 - $4,200

= $1,800 per annum

Depreciation

= Cost - Residual value

Estimated useful life

= $25,200 - 0

6 years

= $4,200 per annum

Accounting rate of return

= Average profit x 100

Initial outlay

= $1,800 x 100

$25,200

= 7.14%

Explanation:

Accounting rate of return is the ratio of average profit to initial outlay multiplied by 100. Average profit is calculated as net cashflow minus depreciation. Depreciation is calculated as cost minus residual value divided by estimated useful life of the machine.

Accounting rate of return is average profit divided by initial outlay multiplied by 100.