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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883

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Survey of Accounting (Accounting I)

8th Edition
Carl Warren
ISBN: 9781305961883
Textbook Problem

Capital rationing decision involving four proposals

Kopecky Industries Inc. is considering allocating a limited amount of capital investmentfunds among four proposals. The amount of proposed investment, estimated income fromoperations, and net cash flow for each proposal are as follows:

The company’s capital rationing policy requires a maximum cash payback period of three years. In addition, a minimum average rate of return of 12% is required on allprojects. 1f the preceding standards are met, the net present value method and presentvalue indexes are used to rank the remaining proposals.

Instructions
Giving effect to straight-line depreciation on the investments and assuming no estimated residual value, compute the average rate of return for each of the four proposals. Round to one decimal place.

To determine

Concept Introduction:

ARR:

Accounting Rate of Return (ARR) is the rate of return earned on the investment made in a project. ARR is calculated by dividing the Average Accounting profits by Average Investment.

The formula to calculate ARR is as follows:

  ARR= Average Accounting profitsAverage Investment

To Calculate:

The Average Rate of Return for each proposal

Explanation

The Average Rate of Return for each proposal is calculated as follows:

    Proposal Sierra
    Income from Operation
    Year 1 $ 80,000
    Year 2 $ 80,000
    Year 3 $ 80,000
    Year 4 $ 30,000
    Year 5 $ (70,000)
    Average Annual Income (D) $ 40,000
    Investment (E) 850,000
    Average Rate of Return (D/E)4.7%
    Proposal Tango
    Income from Operation
    Year 1 $ 320,000
    Year 2 $ 320,000
    Year 3 $ 160,000
    Year 4 $ 60,000
    Year 5 $ (40,000)
    Average Annual Income (D) $ 164,000
    Investment (E) 1,200,000
    Average Rate of Return (D/E)13...

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