Question

The Mickeleson Group has invested $31,000 in a high-tech project lasting three years. Depreciation is $10,100, $13,300, and $7,600 in Years 1, 2, and 3, respectively. The project generates pretax income of $3,830 each year. The pretax income already includes the depreciation expense. The tax rate is 35 percent. What is the project’s average accounting return (AAR)?

Answer 1

The AAR is computed as follows:

= Average annual profit / Average investment

Average annual profit is computed as follows:

= Pretax income x (1 - tax rate)

= $ 3,830 x (1 - 0.35)

= $ 2,489.5

Since in all the three years, profits are same, hence the average annual profit will be $ 2,489.5

Average investment will be as follows:

= $ 31,000 / 2

= $ 15,500

So, the AAR will be as follows:

= $ 2,489.5 / $ 15,500

= 16.06% Approximately