The management of Indiana Corporation is considering the purchase of a new machine costing $400,000. The company's desired rate of return is 10%. The present value factors for $1 at compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621, respectively. In addition to the foregoing information, use the following data in determining the acceptability of this investment:
Year Operating Income Net Cash Flow
1 $100,000 $180,000
2 60,000 120,000
3 30,000 100,000
4 10,000 90,000
5 10,000 90,000
The average rate of return for this investment is:
a. 18%b. 21%c. 53%d. 10%

Option b is correct

Average annual return = 21%

Explanation:

Average rate of return = Average operating income/average investment

Average income = total income for the investment period/Number of years of investment

Average income = (100,000 + 60,000 + 30,000 + 10,000 + 10,000)/5

                         =210,000/5 = 42000

Average investment = (Initial cost + scrap value) / 2

                                  = (400,000 + 0) / 2 = 200,000

Average annual return = 42,000/200,000 × 100

                                     = 21%

Average annual return =21%

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