Olsen Inc. purchased a $590,000 machine to manufacture a specialty tap for electrical equipment. The tap is in high demand and Olsen can sell all that it could manufacture for the next 10 years. To encourage capital investments, the government exempts taxes on profits from new investments in this type of machinery. This legislation most likely will remain in effect in the foreseeable future. The equipment is expected to have 10 years of useful life and no salvage value at the end of this 10-year period. The firm uses straight-line depreciation. The net cash inflow is expected to be $138,000 each year. Olsen uses a discount rate of 14% in evaluating its capital investments.

The accounting (book) rate of return (ARR) based on initial investment for this proposed investment (to two decimal places) is:

13.39%

1. Average annual after-tax profit = Avg. annual cash inflow ? Avg. annual depreciation expense

2. Average annual pre-tax cash inflow (given) = $138,000 (also the annual after-tax cash inflow)

3. Average annual depreciation expense = ($590,000 ? $0)/10 years = $59,000

4. Average annual (after-tax) profit = Average annual pre-tax cash inflow ? average annual depreciation expense ? average annual income tax expense = $138,000 ? $59,000 ? $0 = $79,000

5. ARR = average annual (after-tax) profit/initial investment = $79,000/$590,000 = 13.39% (rounded to two decimal places)