An investment has an initial cost of $410,000 and will generate the net income amounts shown below. This investment will be depreciated straight line to zero over the 4-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 16 percent? Why or why not?
A) Yes; because the AAR is equal to 16 percent
B) Yes; because the AAR is greater than 16 percent
C) Yes; because the AAR is less than 16 percent
D) No; because the AAR is greater than 16 percent
E) No; because the AAR is less than 16 percent

Question

An investment has an initial cost of $410,000 and will generate the net income amounts shown below. This investment will be depreciated straight line to zero over the 4-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 16 percent? Why or why not? 
A) Yes; because the AAR is equal to 16 percent 
B) Yes; because the AAR is greater than 16 percent 
C) Yes; because the AAR is less than 16 percent 
D) No; because the AAR is greater than 16 percent 
E) No; because the AAR is less than 16 percent

Quizplus · Accepted Answer

To calculate the average accounting rate of return (AAR), we need to divide the average annual net income by the initial investment cost.

Average annual net income = Total net income / Number of years 
Total net income = Sum of all net income amounts 
Number of years = 4

Using the formula above, we get:

Average annual net income = ($100,000 + $120,000 + $150,000 + $200,000) / 4 = $142,500

AAR = Average annual net income / Initial investment cost x 100% 
AAR = $142,500 / $410,000 x 100% = 34.76%

The AAR is greater than the required rate of return of 16%, which means that the project should not be accepted based on the AAR method. Therefore, the correct answer is E.

An Investment Has an Initial Cost of $410,000 and Will