Creative Frames, a small artwork framing business, is considering an investment of £40,000 in new machinery. Megan, the business owner, believes that total cash inflows over a 6-year period will be £140,000 and total cash outflows will be £92,000.
Calculate the Average Rate of Return of the proposed investment. (4 marks)
Step 1 - Calculate the total profit over the lifetime of the investment
Total cash inflows - Total cash outflows = Total profit
£140,000 - £92,000 = £48,000 (1 mark)
Step 2 - Divide the total profit by the number of years of the investment project to find the average annual profit
£48,000 ÷ 6 year = £8,000 (1 mark)
Step 3 - Divide the average annual profit by the initial outlay
£8,000 ÷ £40,000 = 0.2 (1 mark)
Step 4 - Multiply the outcome by 100 to find the percentage
0.2 x 100 = 20% (1 mark)