Question
Download Solution PDFIf a project cost is Rs. 40,000. Its stream of earning before depreciation and tax during first year through five years is expected to be Rs. 10,000, Rs. 12,000, Rs. 14,000, Rs. 16,000 and Rs. 20,000. Assume a 50% tax rate and depreciation on straight line basis; project's ARR is
Answer (Detailed Solution Below)
Detailed Solution
Download Solution PDFThe correct answer is 16%
Key Points Accounting Rate of Return:
The accounting rate of return is the ratio of the average after-tax profit divided by the average investment. The average investment would be equal to half of the original investment if it were depreciated constantly.
\(ARR = \frac {Average Income}{Average Investment}\)x100
Important Points Calculation of ARR:
Depreciation is calculated on straight line basis
Therefore, Depreciation = 40000/5 = 8000 per year
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Average |
| Earnings before depreciation, interest and taxes (EBDIT) | 10000 | 12000 | 14000 | 16000 | 20000 | 14400 |
| Depreciation | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 |
| Earnings before interest and taxes (EBIT) | 2000 | 4000 | 6000 | 8000 | 12000 | 6400 |
| Taxes 50% | 1000 | 2000 | 3000 | 4000 | 6000 | 3200 |
| Earnings before interest and after taxes | 1000 | 2000 | 3000 | 4000 | 6000 | 3200 |
Book Value of Investment
| Particulars | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Average |
| Beginning | 40000 | 32000 | 24000 | 16000 | 8000 | |
| Ending | 32000 | 24000 | 16000 | 8000 | 0 | |
| Average | 36000 | 28000 | 2000 | 12000 | 4000 | 20000 |
Average rate of Return = \(\frac {Average Income}{Average investment} \)x 100
Average rate of Return = \(3200 \over 20000\)x100
Average rate of Return = 16%
Last updated on Jun 6, 2025
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