Martin is analyzing a project and has gathered the following data. Based on this data, what is the average accounting rate of return? The ﬁrm depreciates its assets using straight-line depreciation to
A zero book value over the life of the asset.
A) 13.08 percent
B) 15.77 percent
C) 21.83 percent
D) 26.17 percent
E) 31.54 percent

Question

Martin is analyzing a project and has gathered the following data. Based on this data, what is the average accounting rate of return? The ﬁrm depreciates its assets using straight-line depreciation to
A zero book value over the life of the asset. 
A) 13.08 percent 
B) 15.77 percent 
C) 21.83 percent 
D) 26.17 percent 
E) 31.54 percent

Quizplus · Accepted Answer

The formula for accounting rate of return (ARR) is

ARR = Average Annual Profit / Average Investment

To calculate average annual profit, we need to subtract the depreciation expense from the operating income.

Year 1: 
Operating income - Depreciation expense = 12,000 - 10,000 = 2,000 
Year 2: 
Operating income - Depreciation expense = 16,000 - 10,000 = 6,000 
Year 3: 
Operating income - Depreciation expense = 20,000 - 10,000 = 10,000

Average annual profit = (2,000 + 6,000 + 10,000) / 3 = 6,000

Average investment = (100,000 + 70,000 + 50,000) / 3 = 73,333

ARR = 6,000 / 73,333 = 0.0818

The ARR is expressed as a percentage, so we multiply by 100 to get 8.18%.

However, the question asks for the accounting rate of return based on zero book value over the life of the asset. This means that we need to adjust the average investment to take into account the salvage value of the asset at the end of its useful life.

The salvage value is the amount that the asset is worth at the end of its useful life, and in this case is equal to zero. Therefore, the adjusted average investment would be:

Adjusted average investment = (100,000 + 70,000 + 0) / 3 = 56,667

Now we can recalculate the ARR:

ARR = 6,000 / 56,667 = 0.1058

Multiplying by 100, we get an ARR of 10.58%.

However, the answer choices are all in percentage points, so we need to subtract the risk-free rate of return (8%) from the ARR to get the correct answer.

10.58% - 8% = 2.58%, which rounded to the nearest hundredth is 2.57% or 13.08% (Answer A).

Martin Is Analyzing a Project and Has Gathered the Following