The expected average rate of return for a proposed investment of $4,800,000 in a fixed asset, using straight-line depreciation, with a useful life of 20 years, no residual value, and an expected total net income of $10,560,000 over the 20 years is

Question

Quizplus · Accepted Answer

The expected average rate of return can be calculated using the following formula:

Average Annual Income / Initial Investment

The average annual income is the total net income divided by the useful life of the asset, which is:

10,560,000 / 20 = 528,000 per year

The initial investment is $4,800,000.

Using these numbers, we can calculate the expected average rate of return:

528,000 / 4,800,000 = 0.11 or 11%

However, this is only the average rate of return for one year. To calculate the average rate of return over the entire useful life of the asset, we need to use the following formula:

[(Total Income - Total Expenses) / Useful Life] / Initial Investment

Since the asset has no residual value, the total expenses are equal to the initial investment. Therefore:

(10,560,000 - 4,800,000) / 20 / 4,800,000 = 0.22 or 22%

Therefore, the best choice is B, with an expected average rate of return of 22%.

The Expected Average Rate of Return for a Proposed Investment