Question

Why might the accounting rate of return be low in the initial years of an investment?

A. Because the depreciation tax shield is negative

B. Because the investment base will be higher in the initial years

C. Because customers are not willing to spend money in the initial years

D. Because the company must pay cash for the investment at the beginning of the first year

Answer 1

Correct option is "B"- Because the investment base will be higher in the initial years

Accounting rate of return is calculated using the formula :Net income /Average Asset invested

where Average asset invested =[Beginning book value+ending book value]/2

As Depreciation is charged over the useful life ,The book value of asset is decreased and so as average book value of asset invested .Thus higher investment base in initial year causes accounting rate of return to be lower as in initial years book value of asset is higher .