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

To calculate the average accounting return (AAR), we can use the following formula:

AAR = Average Net Income / Average Book Value

Average net income = Total net income / Number of years = $2,100
Average book value = (Initial cost + Salvage value) / 2 = ($65,000 + $0) / 2 = $32,500

AAR = $2,100 / $32,500 = 6.46%

The AAR of 6.46% is less than the required minimal average accounting return of 8.5%, which means the project should be rejected. Therefore, the best choice is D, reject; 6.46%.

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