- 10 Marks
BMF – May 2017 – L1 – SB – Q6 – Investment Decisions
Calculation of ARR for a machine investment and evaluation of the advantages and disadvantages of IRR.
Question
Baseline Limited plans to buy a machine costing N500 million which will last for four years and then be sold for N5 million. Additional working capital in the sum of N5 million will be required as soon as the project starts. Net cash flow before tax is expected to be as follows:
| Period | Net Cash Flow (N millions) |
|---|---|
| Period 1 | 244 |
| Period 2 | 286 |
| Period 3 | 374 |
| Period 4 | 156 |
Baseline Limited has a targeted Return on Capital Employed of 20%. Depreciation is charged on a straight-line basis over the life of an asset.
Required:
What is the Accounting Rate of Return (ARR) of this machine?
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