Reference no: EM133052802
Question - Olafson's Office Supply, Inc., a chain of regional office supply stores headquartered in Fargo, ND, is analyzing two options for its new computer system. With the firm's recent expansion to three additional locations in South Dakota, Olafson's Office Supply has nearly out-grown its current computer system. Customer service has long been a cornerstone of the firm's philosophy for success, so the management team views the computer system analysis as being a very high priority.
Assume that you have recently been hired for the Internship position at Olafson's Office Supply, working out of their corporate headquarters facility in Fargo. For your first project, you have been assigned to complete the computer system analysis using the "Accounting Rate of Return" (ARR) method. Jim Grant, the Office Manager, has compiled the following information for you about the two options that are being considered for the new computer system:
|
|
Option A
|
Option B
|
|
Initial Cost:
|
$525,000
|
$750,000
|
|
Project Life:
|
4 years
|
4 years
|
|
Depreciation Method:
|
Straight-line
|
Straight-line
|
|
Investment Salvage Value on December 31, Year 4:
|
$40,000
|
$65,000
|
|
Expected Cash Inflows as of December 31 Each Year:
|
|
|
|
Year One
|
$175,000
|
$186,900
|
|
Year Two
|
$194,500
|
$214,520
|
|
Year Three
|
$210,250
|
$235,000
|
|
Year Four
|
$215,000
|
$249,000
|
Jim's estimates of the expected cash inflows that each computer system is expected to generate are in comparison to Olafson's Office Supply's current computer system. With the new computer systems being more automated and more efficient, they are expected to produce considerable annual savings in labor cost, along with improved customer service.
The management team of Olafson's Office Supply has determined that they will select the computer system that has the highest "Accounting Rate of Return" (ARR), based on your analysis. Given this information, please answer the following questions.
Required -
1. Compute the "Accounting Rate of Return" (ARR) for Option A.
2. Compute the "Accounting Rate of Return" (ARR) for Option B.
3. Based on your ARR analysis, which computer system should Olafson's Office Supply select? Why?
4. What is an advantage or benefit to using the "Accounting Rate of Return" (ARR) analysis method for capital budgeting?
5. What is a disadvantage or limitation to using the "Accounting Rate of Return" (ARR) analysis method for capital budgeting?