Question

Mountain Frost is considering a new project with an initial cost of $270,000. The equipment will be depreciated on a straight-line basis to a zero book value over the four-year life of the project. The projected net income for each year is $21,300, $22,200, $24,600, and $18,200, respectively. What is the average accounting return?

A) 14.65% B) 15.98% C) 7.99% D) 11.99% E) 17.12%

Answer 1

Solution :

The Average accounting return is calculated using the formula

= Average Net Income / Average Investment

As per the Information given in the question we have

Net Income Year 1 : $ 21,300

Net Income Year 2 : $ 22,200

Net Income Year 3 : $ 24,600

Net Income Year 4 : $ 18,200

No. of years = 4

Thus Average Net income = ( Sum of Net Income earned from Year 1 to Year 4 ) / No. of years

= ( $ 21,300 + $ 22,200 + $ 24,600 + $ 18,200 ) / 4

= $ 86,300 / 4

= $ 21,575

Average Investment = ( Initial Book value + Book value at end of Year 4 ) / 2

= ( $ 270,000 + 0 )/ 2 = $ 135,000

(Book value at end of Year 4 = 0 ; since the plant will be depreciated straight-line to zero over its four-year life )

Thus Average Accounting Return = Average Net Income / Average Investment

= $ 21,575 / $ 135,000 = 0.159815

= 15.9815 %

= 15.98 % ( When rounded off to two decimal places )

Thus the Average accounting rate of return = 15.98 %

The solution is Option B) 15.98 %