Question

An investment has an initial cost of $300,000 and a life of four years. This investment will be depreciated by $60,000 a year and will generate the net income shown below. Should this project be accepted based on the average accounting rate of return (AAR) if the required rate is 29.5 percent? Why or why not? Net Income Year 1 $14,500 16,900 N 3 19,600 4 23,700 Select one: a. No, because the AAR is 29.5 percent b. Yes, because the AAR is 29.5 percent c. No, because the AAR is lower than 29.5 percent d. Yes, because the AAR is greater than 29.5 percent e. Yes, because the AAR less than 29.5 percent

Answer 1

Total depreciation = Depreciation per year * Number of years
= $60,000 * 4
= $240,000

Salvage value = Initial cost - Total depreciation
= $300,000 - $240,000
= $60,000

Average investment = ($300,000 + $60,000) / 2 = $180,000

Average net income = ($14500 + 16900 + 19600 + 23700) / 4
= $74,700 / 4
= $18,675

Average accounting rate of return (ARR) = Average net income / Average investment
= $18,675 / $180,000
= 10.38%

Average accounting rate of return (ARR) is less than the required rate of return. Thus, the project should not be accepted.

Correct answer is Option C.

No, because the AAR is lower than 29.5 percent.