The Drive-Thru requires an average accounting return (AAR) of at least 17 percent on all fixed asset purchases. Currently, it is considering some new equipment costing $168,000. This equipment will have a 4-year life over which time it will be depreciated on a straight line basis to a zero book value. The annual net income from this equipment is estimated at $8,100, $10,300, $17,900, and $19,600 for the four years. Should this purchase occur based on the accounting rate of return? Why or why not?
A) Yes; because the AAR is less than 17 percent
B) Yes; because the AAR is equal to 17 percent
C) Yes; because the AAR is greater than 17 percent
D) No; because the AAR is less than 17 percent
E) No; because the AAR is greater than 17 percent

Question

Quizplus · Accepted Answer

To calculate the AAR, we need to divide the average annual net income by the average investment.

The average annual net income for the 4-year period is (8100 + 10300 + 17900 + 19600) / 4 = $14,975.

The average investment is the initial investment divided by 2, since the equipment is depreciated on a straight-line basis to a zero book value. Therefore, the average investment is $84,000 ($168,000 / 2).

Therefore, the AAR is ($14,975 / $84,000) * 100 = 17.82%.

Since the AAR is less than the required rate of 17 percent, the purchase should not occur based on the accounting rate of return. Therefore, the answer is D.

The Drive-Thru Requires an Average Accounting Return (AAR) of at Least