You own a furniture manufacturing company. You are looking to expand into glass furniture and need to buy new manufacturing equipment to manufacture this type of furniture. You have researched many suppliers but have found that two machines will best suit your needs.  The cost of machine 1 is $90,000, and the cost of machine 2 is $110,000. The estimated net profits the machines will generate are in the following table:Net ProfitMachine 1 (cost $90,000)Machine 2 (cost $110,000)Year 1$20,000$10,000Year 2$30,000$20,000Year 3$40,000$40,000Year 4$20,000$60,000Year 5$20,000$50,000Total$130,000$180,000 Compare the ARR for both machines and decide which machine you should buy.Critically evaluate the ARR technique in evaluating investment options.

Question
Asked Oct 17, 2019
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You own a furniture manufacturing company. You are looking to expand into glass furniture and need to buy new manufacturing equipment to manufacture this type of furniture. You have researched many suppliers but have found that two machines will best suit your needs.  The cost of machine 1 is $90,000, and the cost of machine 2 is $110,000. The estimated net profits the machines will generate are in the following table:

Net Profit

Machine 1 (cost $90,000)

Machine 2 (cost $110,000)

Year 1

$20,000

$10,000

Year 2

$30,000

$20,000

Year 3

$40,000

$40,000

Year 4

$20,000

$60,000

Year 5

$20,000

$50,000

Total

$130,000

$180,000

 

  1. Compare the ARR for both machines and decide which machine you should buy.
  1. Critically evaluate the ARR technique in evaluating investment options. 

 

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Expert Answer

Step 1

Computation of ARR:

Machine 2 can be purchased as it has the higher ARR of 32.73%.

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-SUM(B2:B6)/5 B7 Cc Machine 1 Machine 2 $10,000 $20,000 $40,000 $60,000 $50,000 Year 1 1 $20,000 2 2 S30,000 $40,000 3 4 $20,000 $20,000 $26.000 4 5 5 6 7 Average annual profit (A) 8 Investment (B) 9 ARR (A)(B) S36.000 $90,000 $110,000 28.89% 32.73% LO

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