Desiree, Inc. is considering adding a new product with a start-up cost of $540,000. This cost will be depreciated over 3 years, which is the estimated life of the product. Desiree has a 34% marginal tax rate. The net income for each of the three years is estimated at $15,000, $45,000, and $80,000. What is the average accounting return for the new product?
A) 8.64%
B) 11.30%
C) 17.28%
D) 21.00%
E) 25.93%

Question

Quizplus · Accepted Answer

The average accounting return (AAR) is calculated by dividing the average net income by the average investment. The average net income over the three years is (15,000 + 45,000 + 80,000) / 3 = 46,667. The initial investment is $540,000, which is fully depreciated over 3 years, so the average investment is $540,000 / 2 = $270,000 (assuming straight-line depreciation and that the average investment is the midpoint of the initial and final book value). Thus, AAR = (46,667 / 270,000) * 100 = 17.28%.