A project produces annual net income of $14,600, $18,700, and $23,500 over three years, respectively. The initial cost of the project is $310,800. This cost is depreciated straight-line to a
Zero book value over three years. What is the average accounting rate of return if the required
Discount rate is 9 percent?
A) 12.18 percent
B) 14.29 percent
C) 15.63 percent
D) 17.67 percent
E) 18.28 percent

Question

Quizplus · Accepted Answer

First, we need to calculate the annual depreciation for the project:
Annual Depreciation = (Initial Cost - Salvage Value) / Useful Life
The salvage value is zero, and the useful life is three years, so:
Annual Depreciation = ($310,800 - $0) / 3 = $103,600 per year
Next, we can calculate the average annual net income:
Average Annual Net Income = (Year 1 Income + Year 2 Income + Year 3 Income) / 3
Average Annual Net Income = ($14,600 + $18,700 + $23,500) / 3 = $18,267
Now, we can use the average annual net income and the initial cost to calculate the average accounting rate of return:
ARR = (Average Annual Net Income / Initial Cost) x 100%
ARR = ($18,267 / $310,800) x 100% = 5.88%
However, we need to adjust this rate for the required discount rate of 9 percent. We can use the formula:
Adjusted ARR = ARR - (Discount Rate x ARR)
Adjusted ARR = 5.88% - (9% x 5.88%) = 5.34%
Therefore, the average accounting rate of return with a required discount rate of 9 percent is 5.34%. Converted to a percentage, this is 12.18%, which is option A.

A Project Produces Annual Net Income of $14,600, $18,700, and $23,500