Chapter 11, Problem 3.1GBP

To determine

Concept introduction:

Accounting rate of return: It is a rate at which a company can earn profit on the amount invested initially. It is calculated by dividing the average inflow with the initial cost of the project.

To calculate:

Accounting rate of return.

Answer to Problem 3.1GBP

Project 1: ARR=25 %

Project 2: ARR=20.12 %

Project3: ARR=13 %

It is better to accept project 1.

Explanation of Solution

Accounting rate of return for each project is calculated as follows:

Project-1:

Accounting rate of return = Average net Income* 100/ Initial Outflow

= (975000 - (2700000-600000)/7) *100/ 2700000

= (975000 - 300000)* 100/ 2700000

= 25%

Average Net Income = Cash Inflow - Depreciation

Depreciation = 2700000-600000)/7 = 300000

Project-2:

$\begin{array}{l}AccountingRateofreturn=Averagecashinflow*100/InitialOutflow\hfill \\ \hfill \\ =1650000*100/8200000\hfill \\ =20.12\%\hfill \end{array}$

Project-3:

$\begin{array}{l}AccountingRateofreturn=Averagecashinflow*100/InitialOutflow\hfill \\ \hfill \\ =\left(30000*10+2500*10\right)/10*100/25000*10\hfill \\ \hfill \\ =32500*100/250000\hfill \\ \hfill \\ =13\%\hfill \end{array}$

As per accounting rate of return, it is better to accept project 1 because it has the highest ARR.