Question

Accounting rate of return lo p2 information for two alternative projects involving machinery investments follows: project 1 project 2 initial investment $ (138,000) $ (108,000) salvage value 0 18,000 annual income 17,250 15,120.

compute accounting rate of return for each project.

Answer 1

The Accounting Rate of Return for Project 1 is 12.5%, calculated by dividing the annual income by the initial investment. For Project 2, the ARR is 14%, calculated similarly, but not considering the salvage value in the ARR calculation.

Step-by-step explanation:

To compute the Accounting Rate of Return (ARR), we use the formula: ARR = Average Annual Profit / Initial Investment. For Project 1, there is no salvage value, so the average annual profit is the annual income of $17,250. The ARR for Project 1 is $17,250 / $138,000 = 0.125 or 12.5%. For Project 2, the salvage value affects the average annual profit because it reduces the initial investment cost over the life of the project. Therefore, the ARR for Project 2 is ($15,120 annual income + $18,000 salvage value) / $108,000 initial investment, but since salvage value is realized at the end of the project life, we omit it from average annual income and treat it as a reduction in initial cost. The ARR for Project 2, therefore, remains based solely on the annual income: $15,120 / $108,000 = 0.14 or 14%.

For Project 1:

Accounting rate of return = Annual income / Initial investment

= $17,250 / $138,000

= 0.125 or 12.5%

For Project 2:

Accounting rate of return = Annual income / Initial investment

= $15,120 / $108,000

= 0.139 or 13.9%

Therefore, the accounting rate of return for Project 1 is 12.5% and for Project 2 is 13.9%.