Can anyone please help me how to solve this problem?

Grocery Freshly want to open a new store. They expect an initial cost of 30,000 to buy the property in which the store will be. After opening, the annual cost of 10,000 is expected to generate 13,000 over the next 10 years. Real estate will be depreciated by regular yearly depreciation (after 10 years the whole property will be depreciated). Does opening such a store looks like a good idea in terms of accounting profitability, if the price of capital is 8% p.a., profit tax 30% and we require at least 10% p.a. accounting profitability? Consider continuous interest.

So I thought that the net accounting value is 0, since the whole property will be depreciated, average annual profit is 2100, since 13000-10000=3000, however without tax it is 2100 and Investment=30000

So my formula is:

ARR(Accounting rate of return)=$\frac{2100}{30000/2}=0.14$

Is that correct?

  • $\begingroup$ You haven’t included depreciation in your accounting profit calculation. $\endgroup$ – dm63 Jan 1 at 14:56
  • $\begingroup$ @dm63 yes, but I thought it is zero, can you explain me how to calculate it? $\endgroup$ – Daniel Jan 1 at 16:06

Annual Accounting Profit = Revenues -costs - depreciation

Revenues =13000

Costs= 10000

Annual depreciation = 30000/10yrs = 3000

Therefore annual accounting profit =0

If you believe that the property market value will indeed depreciate like this, it doesn’t seem like a good investment.

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  • $\begingroup$ Thank you, I think that was the key $\endgroup$ – Daniel Jan 2 at 10:09

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