Siesta Manufacturing has asked you to evaluate a capital investment project. The project will require an initial investment of $54,000. The life of the investment is 6 years with a residual value of $6,000. If the project produces net annual cash inflows of $20,000, what is the accounting rate of return? (Round any intermediary calculations to the nearest dollar and your final answer to two decimal places, X.XX%.)

Question

Quizplus · Accepted Answer

The accounting rate of return can be calculated by dividing the average annual profit by the initial investment and expressing the result as a percentage.

Average annual profit = (Total cash inflows - Initial investment + Residual value) / Number of years 
= (20,000 - 54,000 + 6,000) / 6 
= $3,000

Accounting rate of return = (Average annual profit / Initial investment) x 100% 
= (3,000 / 54,000) x 100% 
= 5.56%

Therefore, the accounting rate of return is 5.56% per year.

Since Siesta Manufacturing has a required rate of return or minimum acceptable rate of return for investment projects, which is not given in the problem, it cannot be determined whether the project is acceptable based on the accounting rate of return alone. Other methods such as net present value or internal rate of return may need to be used to make a decision.

Siesta Manufacturing Has Asked You to Evaluate a Capital Investment