Question

Copa Cabana Corporation is considering the purchase of a new machine costing $30,000. The machine would generate net cash inflows of $12,000 per year for 5 years. At the end of 5 years, the machine would have no salvage value. Copa Cabana’s cost of capital is 12 percent. Copa Cabana uses straight-line depreciation. The investment's accounting rate of return on initial investment is: Select one: A. 10.27 percent B. 12.28 percent C. 20.00 percent D. 30.55 percent

Answer 1

Answer:

C. 20.00 percent

Explanation:

The computation of the accounting rate of return is shown below:

The formula to compute the accounting rate of return is shown below:

= Annual net income ÷ initial investment

where,  

Annual net income is

= Net cash flows - depreciation expense

= $12,000 - $6,000

= $6,000

And, the initial investment is $30,000

So, the accounting rate of return on initial investment is

= $6,000 ÷ $30,000

= 20%

The depreciation expense is

= $30,000 ÷ 5 years

= $6,000