A project has average net income of $2,100 a year over its 4-year life. The initial cost of the project is $65,000 which will be depreciated using straight-line depreciation to a book value of zero over the life of the project. The firm wants to earn a minimal average accounting return of 8.5 %. The firm should _____ the project based on the AAR of _____
A) Accept; 6.46 %.
B) Accept; 9.69 %.
C) Accept; 12.92 %.
D) Reject; 6.46 %.
E) Reject; 12.92 %.

Question

Quizplus · Accepted Answer

The Average Accounting Return (AAR) is calculated as the average net income divided by the average investment. The average investment is the sum of the beginning and ending book values divided by 2. Since the project depreciates to zero, the average investment is $65,000 / 2 = $32,500. The AAR = ($2,100 / $32,500) * 100 = 6.46%. Since the firm wants a minimum AAR of 8.5%, the project's AAR of 6.46% does not meet this requirement, hence it should be rejected.

A Project Has Average Net Income of $2,100 a Year