An investment has an initial cost of $410,000 and will generate the net income a

Question

An investment has an initial cost of $410,000 and will generate the net income amounts shown below. This investment will be depreciated straight line to zero over the 4-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 16 percent? Why or why not?
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A. Yes; because the AAR is equal to 16 percent
B. Yes; because the AAR is greater than 16 percent
C. Yes; because the AAR is less than 16 percent
D. No; because the AAR is greater than 16 percent
E. No; because the AAR is less than 16 percent

Explanation / Answer

Hi,

Please find the answer as follows:

Average Income = (21000 + 24800 + 37500 + 45000)/4= 32075

Average Investment = 410000/2 = 205000

AAR = Average Income/Average Investment*100 = 32075/205000*100 = 15.64%

Option E (No; because the AAR is less than 16 percent) is correct.

Thanks.

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