Meeta Ltd is considering investing in a project requiring a capital ou...
Calculation of Accounting Rate of Return
Step 1: Calculation of Annual Depreciation
Annual Depreciation is calculated as 20% of the original cost i.e. Rs 400000 * 20% = Rs 80000.
Step 2: Calculation of Annual Net Income after Depreciation
Annual Net Income after Depreciation is calculated as Annual Income - Annual Depreciation.
- Year 1: Rs 200000 - Rs 80000 = Rs 120000
- Year 2: Rs 200000 - Rs 80000 = Rs 120000
- Year 3: Rs 160000 - Rs 80000 = Rs 80000
- Year 4: Rs 160000 - Rs 80000 = Rs 80000
- Year 5: Rs 80000 - Rs 80000 = Rs 0
Step 3: Calculation of Annual Net Income after Tax
Annual Net Income after Tax is calculated as Annual Net Income after Depreciation - Income Tax.
- Year 1: Rs 120000 - (50% * Rs 120000) = Rs 60000
- Year 2: Rs 120000 - (50% * Rs 120000) = Rs 60000
- Year 3: Rs 80000 - (50% * Rs 80000) = Rs 40000
- Year 4: Rs 80000 - (50% * Rs 80000) = Rs 40000
- Year 5: Rs 0 - (50% * Rs 0) = Rs 0
Step 4: Calculation of Average Annual Net Income after Tax
Average Annual Net Income after Tax is calculated as the sum of Annual Net Income after Tax for all years divided by the number of years.
Average Annual Net Income after Tax = (Rs 60000 + Rs 60000 + Rs 40000 + Rs 40000 + Rs 0) / 5 = Rs 32000
Step 5: Calculation of Accounting Rate of Return
Accounting Rate of Return is calculated as Average Annual Net Income after Tax divided by the original cost multiplied by 100%.
Accounting Rate of Return = (Rs 32000 / Rs 400000) * 100% = 8%
Explanation
Accounting Rate of Return is a financial ratio that measures the profitability of an investment. It is calculated by dividing the average annual net income after tax by the original cost of the investment. In this case, the accounting rate of return is 8%, which means that the investment is expected to generate an average annual net income after tax of Rs 32000 for every Rs 400000 invested. This ratio helps the management of Meeta Ltd to evaluate the investment opportunity and make informed decisions about whether to invest or not.