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.

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