Stacey W., controller for Graham Industries, is considering the purchase of a ma

Question

Stacey W., controller for Graham Industries, is considering the purchase of a machine costing $60,400 with a 5-year useful life with no residual value. Graham Industries uses straight-line depreciation. The machine would generate cash inflows of $38,000 each year, at the end of the year. The machine’s operating cost would be $12,600 per year, at the end of the year, excluding depreciation expense. Graham Industries uses a 12% hurdle rate. What is the machine’s accounting rate of return?

a. 22.1%

b. 10.1%

c. 32.1%

d. 42.9%

Explanation / Answer

Annual depreciation = Cost of machine/life

                                       = 60400/5

                                      = 12080

Cash inflow from the machine is 38000,

Net cash inflow = 38000 – Depreciation – operating cost

                             = 38000 – 12080 – 12600

                             = 13320

Accounting rate of return = Annual income/initial cost

                                               = 13320/60400

                                                = .221 or 22.1%

Correct option is A

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