Which one of the following statements is correct concerning the average accounting return (AAR)?
A) The average book value used in the AAR formula will always equal one-half of the initial investment as long as straight-line depreciation over the life of the project is used.
B) The average net income is the same as the total cash ﬂows from the project minus the initial cash outﬂow to start the project.
C) The AAR is similar to the proﬁtability index in that both are based on accounting values rather than ﬁnancial cash ﬂows.
D) Under the AAR rule, a project should be accepted if the targeted AAR is greater than the project's AAR.
E) The AAR is a true ﬁnancial rate of return, which is relatively easy to compute.

Question

Quizplus · Accepted Answer

The average book value used in the AAR formula is equal to the initial investment divided by two, regardless of the depreciation method used. Therefore, statement A is correct. Statement B is incorrect because the average net income is the total net income divided by the life of the project, and does not take into account the timing or size of cash flows. Statement C is incorrect because the profitability index is based on the present value of cash inflows, while the AAR is based on accounting values. Statement D is incorrect because the AAR is not used as a decision rule for accepting or rejecting projects. Statement E is incorrect because the AAR is not a true financial rate of return as it is based on accounting values, and it can be affected by non-cash items such as depreciation.

Which One of the Following Statements Is Correct Concerning the Average