10.10) Average Accounting Rate of Return (ARR): Capitol Corp. management is expe

Question

10.10) Average Accounting Rate of Return (ARR): Capitol Corp. management is expecting a project to generate after-tax income of $63,435 in each of the next three years. The average book value of the project's equipment over that period will be $212,500. If the firm's acceptance decision on any project is based on an ARR of 37.5 percent, should this project be accepted?

10.16) Net Present Value: Emporia Mills Management is evaluating two alternative heating systems. Cost and projected energy savings are given in the following table. The firm uses 11.5 percent to discount such project cash flows. Which system should be chosen?

Year

System 100

System 200

0

$(1,750,000)

$(1,735,000)

1

$275,223

$750,000

2

$512,445

$612,500

3

$648,997

$550,112

4

$875,000

$384,226

Explanation / Answer

10.10)

Annual After Tax Income = 63,435

Average After Tax Income = (63,435 + 63,435 + 63,435)/3 = 63,435

Average Book Value Of Equipment = 212,500

Accounting Rate Of Return = Average after-Tax Income/Average book value = 63,435/212,500 = 29.9%

Since Project's ARR is below the acceptance rate of 37.5 percent ,the project should be rejected

10.16)

Required rate of return = 11.5%

System 100 :

Cost of production line expansion = 1,750,000

NPV = -1.750,000 + (275,223/1.115) -(512,445/1,115^2) + (648,997/1,115^3) + (875,000/1.11564)

= -56,667

System 200 :

Cost of production line expansion = 1,735,000

NPV = -1,735,000 + (750,00/1.115) - (612,500/1.115^2) + (550,112/1.115^3) + (384,226/1.115^4)

= 75,758

Since System 200 has positive NPV select that system

Since System 100 has negative NPV reject that system

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