An investment has an initial cost of $2.7 million and net income of $189,400, $178,600, and $172,500 for Years 1 to 3.This investment will be depreciated by $900,000 a year over the three-year life of the project.Should this project be accepted based on the average accounting rate of return if the required rate is 12.5 percent? Why or why not?
A)Yes, because the AAR is 12.5 percent
B)Yes, because the AAR is less than 12.5 percent
C)Yes, because the AAR is greater than 12.5 percent
D)No, because the AAR is greater than 12.5 percent
E)No, because the AAR is less than 12.5 percent

Question

Quizplus · Accepted Answer

The average accounting rate of return (AAR) is calculated as the average annual net income divided by the average investment. The average annual net income is the sum of the net income for each year divided by the number of years. The average investment is the initial cost of the investment plus the depreciation expense for each year divided by the number of years.In this case, the average annual net income is (189,400 + 178,600 + 172,500) / 3 = $180,166.67. The average investment is (2,700,000 + 900,000 + 900,000 + 900,000) / 3 = $1,800,000. Therefore, the AAR is 180,166.67 / 1,800,000 = 10.01%.Since the AAR (10.01%) is greater than the required rate (12.5%), the project should be accepted.

An Investment Has an Initial Cost of $2