Question

Key Lock Co. wants to determine if they should expand their business into more locations. Total initial costs are $12.5 million, as recorded in the financial statement, which will be depreciated straight-line to 0 over a four- year life. If the projected net income from the project is $1,368,000, $1,935,000, $1,738,000, and $1,310,000 over the four years, what is the project’s average accounting return (AAR)?

Answer 1

Average investment = (Initial investment - last book value) / 2

Average investment = (12,500,000 - 1) / 2

Average investment = 6,250,000

Average income = (1,368,000 + 1,935,000 + 1,738,000 + 1,310,000) / 4

Average income = 1,587,750

average accounting return (AAR) = (Average income / average investment) * 100

average accounting return (AAR) = (1,587,750 / 6,250,000) * 100

average accounting return (AAR) = 25.40%