O'Mally Department Stores is considering two possible expansion plans. One proposal involves opening 5 stores in Indiana at the cost of $1,810,000. Under the other proposal, the company would focus on Kentucky and open 6 stores at a cost of $2,000,000. The following information is available: The accounting rate of return for the Indiana proposal is closest to (Round any intermediary calculations to the nearest dollar, and round your final answer to the nearest hundredth of a percent, X.XX%.)

Question

O'Mally Department Stores is considering two possible expansion plans. One proposal involves opening 5 stores in Indiana at the cost of $1,810,000. Under the other proposal, the company would focus on Kentucky and open 6 stores at a cost of $2,000,000. The following information is available:  The accounting rate of return for the Indiana proposal is closest to (Round any intermediary calculations to the nearest dollar, and round your final answer to the nearest hundredth of a percent, X.XX%.)

Quizplus · Accepted Answer

First, calculate the average annual net income for each proposal by taking the total net income over the life of the investment and dividing by the number of years:

For the Indiana proposal:
Net income = $270,000/year x 5 stores = $1,350,000/year
Average annual net income = $1,350,000 / 5 years = $270,000/year

For the Kentucky proposal:
Net income = $384,000/year x 6 stores = $2,304,000/year
Average annual net income = $2,304,000 / 5 years = $460,800/year

Next, calculate the average investment for each proposal by taking half of the initial investment and adding any salvage value, then dividing by the number of years:

For the Indiana proposal:
Average investment = ($1,810,000/2 + 0) / 5 years = $181,000/year

For the Kentucky proposal:
Average investment = ($2,000,000/2 + 0) / 5 years = $200,000/year

Finally, calculate the accounting rate of return for each proposal by dividing the average annual net income by the average investment:

For the Indiana proposal:
ARR = $270,000 / $181,000 = 1.49 or 149%

For the Kentucky proposal:
ARR = $460,800 / $200,000 = 2.30 or 230%

Therefore, the Kentucky proposal has a higher accounting rate of return and is the better choice.

O'Mally Department Stores Is Considering Two Possible Expansion Plans