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$180,000a) Compare the ARR for both machines and decide which machine you should buy. [Note: you are supposed to show every step of your calculation and interpret the result.] b) Critically evaluate the ARR technique in evaluating investment options. [Note: remember to use Harvard referencing to reference your sources]

Question
Asked Nov 27, 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

a) Compare the ARR for both machines and decide which machine you should buy. [Note: you are supposed to show every step of your calculation and interpret the result.]

 

b) Critically evaluate the ARR technique in evaluating investment options. [Note: remember to use Harvard referencing to reference your sources] 
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Expert Answer

Step 1

Calculation of ARR:

The ARR for Machine 1 is 28.89% and Machine 2 is 32.73%.

Excel Spreadsheet:

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В А C Year Machine 1 Machine 2 $90,000 $110,000 $10,000 $20,000 $40,000 $60,000 $50,000 3 $20,000 1 $30,000 $40,000 $20,000 $20,000 8 Average Cash Flow $26,000 2 4 3 5 6 4 5 7 $36,000 ARR 32.73% 9 28.89%

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Step 2

Excel Workings:

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А В C Machine 1 Machine 2 1 Year 90000 20000 30000 40000 20000 20000 2 0 110000 10000 20000 40000 60000 50000 3 1 4 2 5 3 6 4 7 5 Average Cash Flow =AVERAGE(B3:B7)| =AVERAGE(C3:C7) =B8/B2 8 -C8/C2 ARR

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Step 3

From the below calculations, Machine 2 should be purchased, since it has a higher accounting rate of return compared to Machine 1.

Theref...

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