Question

Accrual Accounting Rate of Return and NPV Sally's Bar is considering purchasing a new cooler. Purchase price is $300,000. An additional $25,000 will be spent on working capital, which will be recovered at the end of the life of the cooler. The cooler is expected to last for three years, with a salvage value of $30,000 at the end of it's useful life. The machine is expected to create $125,000, $150,000 and $175,000 in cash savings in each of the three years respectfully. The company uses straight-line depreciation. Assume a 40% tax rate. a. Calculate the accrual accounting rate of return on the initial investment. b. Calculate the NPV for the investment assuming the company requires a 10% rate of return.

Answer 1

A)

Depreciation per year = $300000-$30000/3 = $90000 per year

Accrual ARR = (Average net income)/(Initial investment)

Income for three years:

1st Year = $125000 - $90000 = $35000

2nd Year = $150000 - $90000 = $60000

3rd Year = $175000 - $90000 = $85000

Average annual net income = $35000+$60000+$85000 / 3 = $60000

Computation of accrual ARR
				S.No.	Particulars	$	$
A	Purchase price	300000
	Working capital invested	25000
	Initial Investment		325,000
B	Average net income		60,000
C	Accrual accounting rate of return ( B/A)		0.18461538

Hence accrual ARR = 18.4615%

B)

Computation of NPV
			Year
	Rate of return	10%
0	Initial cash outflow	$ -3,25,000.00
1	cash inflow	$   1,25,000.00
2	cash inflow	$   1,50,000.00
3	cash inflow            ($175000 + $30000+ $25000)	$   2,30,000.00
	Net present Value	$ 77,641.55

Note: I have used direct excel formula to compute NPV.