The accounting rate of return of the proposed investment

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Reference no: EM133265567

Ridag Co is evaluating investment project, as follows.

This is an investment in new machinery to produce a recently-developed product. The cost of the machinery, which is payable immediately, is $1.5 million, and the scrap value of the machinery at the end of four years is expected to be $100,000. Capital allowances (tax-allowable depreciation) can be claimed on this investment on a 25% reducing balance basis. Information on future returns from the investment has been forecast to be as follows:

Year 1 2 3 4

Sales volume (units/year) 50,000 95,000 140,000 75,000

Selling price ($/unit) 26.00 25.96 25.87 26.91

Variable cost ($/unit) 10.25 11.56 12.92 13.80

Fixed costs ($/year) 105,000 115,000 125,000 125,000

Selling price per unit, variable cost per unit and fixed costs which are wholly attributable to the project, have already been adjusted for inflation. Ridag Co pays profit tax of 30% per year one year in arrears. Ridag uses an after-tax discount rate (cost of capital) of 7% when appraising the new investment

Required:

a) Net cash flows from year 1 to year 4

b) Payback period of the proposed investment

c) The accounting rate of return of the proposed investment

Reference no: EM133265567

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