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The Wet Corporation contemplates the replacement of an old machinery. The annual cost of operating the...

The Wet Corporation contemplates the replacement of an old machinery. The annual cost of operating the old machinery is P138,600, excluding depreciation, while the estimate for the new machinery is P91,300. The cost of the new machinery is P160,000, net of the trade-in allowance, with an estimated useful life of 8 years, no residual value. The effective income tax rate of 40% and the cost of capital is 8%. The old machinery has an annual deprecation of P15,000 while the new machinery is estimated to have an annual depreciation of P20,000. The book value of the old machinery is zero.

Required. Accounting rate of return on average investment

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Expert Solution

Accounting Rate of Return (ARR) = Incremental Net Income / Average Investment

--> Incremental Net Income (Incremental Income minus Incremental Cost):

A) Incremental Income = Decrease in annual operating cost = 138600 - 91300 = 47300

B) Incremental Cost = Increase in Depreciation = 20000-15000 = 5000

Therefore, Incremental Net Income = Incremental Income - Incremental Cost = 47300-5000 = 42300

--> Average Investment = (Initial Investment + Salvage Value)/2

Therefore, Average Investment = (160000+0) / 2 = 80000

--> Therefore, ARR = Incremental Net Income / Average Investment

Therefore, ARR = 42300 / 80000 = 0.5288 = 52.88%

jeff jeffy answered 2 years ago
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