You’re trying to determine whether or not to expand your business by building a
ID: 2621105 • Letter: Y
Question
You’re trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $24.2 million, which will be depreciated straight-line to zero over its four-year life.
If the plant has projected net income of $2,095,000, $2,285,000, $2,314,000, and $1,466,000 over these four years, what is the project’s average accounting return (AAR)? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
You’re trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $24.2 million, which will be depreciated straight-line to zero over its four-year life.
Explanation / Answer
Average net income=Total net income/Total time period
=(2095000+2285000+2314000+1466000)/4=$2,040,000
Average investment=(Cost+Salvage value)/2=($24.2million+0)/2=$12,100,000
Average accounting return=Average net income/Average investment
=$2,040,000/$12,100,000
=16.86%(Approx).
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