An investment has an initial cost of $462,000 and will generate the net income a

Question

An investment has an initial cost of $462,000 and will generate the net income amounts shown below. This investment will be depreciated straight-line to zero over the four-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 14.75 percent? Why or why not

A. No, because the AAR is less than 14.75 percent

B. No, because the AAR is greater than 14.75 percent

C. Yes, because the AAR is equal to 14.75 percent

D. Yes, because the AAR is greater than 14.75 percent

E. Yes, because the AAR is less than 14.75 percent

Explanation / Answer

Computation of AAR:

AAR = Average net income / average investment

Average net income = ($27,000 + $24,800 + $37,500 + $45,000) / 4 = $33,575

Average investment = (Book value at beginning + book value at end) / 2

= ($4,62,000+ 0) / 2

= $2,31,000

AAR = Average net income / average investment

= $33,575 / $2,31,000

= 0.1453

= 14.53%

AAR= 14.53%

Project should be rejected,since AAR < Required rate.

Answer : A

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