Answers
1. Sandbox Toy Project's ARR is 10.30%. Calculation is as below:
| Particulars | Toy Action Project | Sandbox Toy Project |
| Cost of Machine | 1000000 | 1000000 |
| No. of years of useful life | 5 | 5 |
| Salvage Value | 0 | 0 |
| Depreciation per year = (Cost of Machine - Salvage Value) / No. of years of useful life | 200000 | 200000 |
| Cash Inflow: | ||
| Year 1 | 336700 | 550000 |
| Year 2 | 336700 | 340000 |
| Year 3 | 336700 | 310000 |
| Year 4 | 336700 | 275000 |
| Year 5 | 336700 | 40000 |
| Total Inflow | 1683500 | 1515000 |
| Net Profit (with no salvage value) = Total Inflow - (Cost of Machine - Salvage Value) | 683500 | 515000 |
| Average Annual Profit = Net Profit / No. of years of useful life | 136700 | 103000 |
| Accounting Rate of Return (ARR) = Average Annual Profit / Cost of Machine | 13.67% | 10.30% |
2.
If the Sandbox project has a residual / salvage value of $1,50,000, then the ARR would be 13.30%. This is because the net inflow will increase with the amount of Residual Value and hence the average annual profit will increase; thereby increasing the ARR. Calculation is as below:
| Particulars | Toy Action Project | Sandbox Toy Project |
| Cost of Machine | 10,00,000 | 10,00,000 |
| No. of years of useful life | 5 | 5 |
| Salvage Value | - | 1,50,000 |
| Depreciation per year = (Cost of Machine - Salvage Value) / No. of years of useful life | 2,00,000 | 1,70,000 |
| Cash Inflow: | ||
| Year 1 | 3,36,700 | 5,50,000 |
| Year 2 | 3,36,700 | 3,40,000 |
| Year 3 | 3,36,700 | 3,10,000 |
| Year 4 | 3,36,700 | 2,75,000 |
| Year 5 | 3,36,700 | 40,000 |
| Total Inflow | 16,83,500 | 15,15,000 |
| Net Profit (with np salvage value) = Total Inflow - (Cost of Machine - Salvage Value) | 6,83,500 | 6,65,000 |
| Average Annual Profit = Net Profit / No. of years of useful life | 1,36,700 | 1,33,000 |
| Accounting Rate of Return (ARR) = Average Annual Profit / Cost of Machine | 13.67% | 13.30% |
3.
For a project to pass the screening rule, it should have a payback period of less than 3.5 years and ARR of more than 8%. With these rules, both the project will pass the screening rule as the ARR for both the projects is more than 8% (with or without residual value) and payback period for both the projects is less than 3.5 years (calculation as below).
| Projected | |||||||
| Toy Action Figure Project | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Total | |
| Yearly cash flow | $ (10,00,000) | $ 3,36,700 | $ 3,36,700 | $ 3,36,700 | $ 3,36,700 | $ 3,36,700 | |
| Cumulative Net Cash Flow | (6,63,300) | (3,26,600) | 10,100 | 3,46,800 | 6,83,500 | ||
| Whether positive cash flow | FALSE | FALSE | TRUE | TRUE | TRUE | ||
| Fraction for positive cash flow (Cumulative Net Cash Flow / Net Cash Flow) | 0.03 | ||||||
| Net time for Pay back period (1-fraction for positive cash flow) | 0.97 | ||||||
| Total Payback period | 1.0 | 1.0 | 0.97 | - | - | 2.97 | |
| Projected | |||||||
| Sandbox Toy Project | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Total | |
| Yearly cash flow | $ (10,00,000) | $ 5,50,000 | $ 3,40,000 | $ 3,10,000 | $ 2,75,000 | $ 40,000 | |
| Cumulative Net Cash Flow | (4,50,000) | (1,10,000) | 2,00,000 | 4,75,000 | 5,15,000 | ||
| Whether positive cash flow | FALSE | FALSE | TRUE | TRUE | TRUE | ||
| Fraction for positive cash flow (Cumulative Net Cash Flow / Net Cash Flow) | 0.65 | - | - | ||||
| Net time for Pay back period (1-fraction for positive cash flow) | 0.35 | - | - | ||||
| Total Payback period | 1.0 | 1.0 | 0.35 | 2.35 | |||
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