Question

Information for two alternative projects involving machinery investments follows: Project 1 Project 2 Initial investment $ (123,000) $ (93,000) Salvage value 0 13,000 Annual income 14,145 12,720 a. Compute accounting rate of return for each project. b. Based on accounting rate of return, which project is preferred

Answer 1

The accounting rate of return for project 1 is 23%.

The accounting rate of return for project 2 is 32%.

Based on accounting rate of return, the preferred project is project 2.

What is the accounting rate of return for each project?

The accounting rate of return is a capital budgeting method used to determine if a firm should invest in a project or should not invest in a project.

Accounting rate of return = Average net income / Average book value

Average book value = (cost of equipment - salvage value) / 2

Accounting rate of return for project 1 = 14,145 / [123,000 / 2] = 0.23 = 23%

Accounting rate of return for project 2 = 12,720 / [(93,000 - 13,000) / 2] = 0.32 = 32%

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