The Blue Moon is considering a project which will produce sales of $120,000 a year for the next five years. The profit margin is estimated at 5.5 %. The project will cost $140,000 and will be depreciated straight-line to a book value of zero over the life of the project. The firm has a required accounting return of 9.5 %. This project should be _____ because the AAR is _____ %.
A) Rejected; 4.71
B) Rejected; 8.57
C) Rejected; 9.43
D) Accepted; 9.67
E) Accepted; 9.43

Question

Quizplus · Accepted Answer

Explanation: The Average Accounting Return (AAR) is calculated based on the average annual profit divided by the average investment. The profit is sales times the profit margin, so $120,000 * 5.5% = $6,600. The average investment is the initial cost divided by 2 (since it's depreciated straight-line to zero), so $140,000 / 2 = $70,000. The AAR = ($6,600 / $70,000) * 100 = 9.43%. However, since the required accounting return is 9.5%, and 9.43% is less than the required return, the project should be rejected. The correct calculation of AAR is 9.43%, but the decision in the options provided does not match this calculation correctly, indicating a mistake in my explanation regarding the choice provided. The correct approach to determine the decision (accepted or rejected) based on the AAR compared to the required return was misunderstood.

The Blue Moon Is Considering a Project Which Will Produce