Woodcrafters requires an average accounting return (AAR) of at least 17 percent

Question

Woodcrafters requires an average accounting return (AAR) of at least 17 percent on all fixed asset purchases. Currently, it is considering some new equipment costing $178,000. This equipment will have a four-year life over which time it will be depreciated on a straight-line basis to a zero book value. The annual net income from this equipment is estimated at $10,100, $10,300, $17,900, and $19,600 for the four years. Should this purchase occur based on the accounting rate of return? Why or why not?

Options:

a) No, because the AAR is greater than 17 percent b) Yes, because the AAR is less than 17 percent c) Yes, because the AAR is equal to 17 percent d) No, because the AAR is less than 17 percent e) Yes, because the AAR is greater than 17 percent

Explanation / Answer

step1:

calculate depriciation per year

dpericiation = 178000/4 = 44500

step2:

calculate average net income

= (10100 + 10300 + 17900 + 19600)/4

= 14475

step3:

calculate average accounting net income

= 14475 - 44500

= -30025

step4:

average accounting rate of return = average accounting income/initial investment

= -30025/178000

= -16.87%

hence the coorect choice is d) Since ARR is less than the required 17%

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