Question

The average rate of return is another method that does not use present value and is commonly used in making capital investment decisions. Unlike the cash payback method, the average rate of return focuses on income rather than cash flow.

Assume that the investment involves an initial outlay of $100,000 with a five-year useful life and no salvage value under straight-line depreciation. The revenues are as follows: Year 1 - $10,000, Year 2 - $20,000, Year 3 - $30,000, Year 4 - $40,000 and Year 5 - $50,000.

Use the minus sign to indicate a net loss. If an amount is zero, enter "0".

Year		Revenues		Expenses		Net Income
Year 1 Net Income (loss)	=	$	-	$	=	$
Year 2 Net Income (loss)	=		-		=
Year 3 Net Income (loss)	=		-		=
Year 4 Net Income (loss)	=		-		=
Year 5 Net Income (loss)	=		-		=

Total Net Income (five years) = $

Average Net Income =

$

= $

Average Rate of Return =

$ $

=  %

Answer 1

Initial Outlay :- $1,00,000

Useful Life :- 5 Years

Salvage Value :- $0

Method of Depreciation :- Straight Line

Depreciation per year :- $20,000 ($1,00,000/5)

Year	Revenues	Expenses	Net Income
Year 1 Net Profit / (Loss)	$10,000	$20,000	-$10,000
Year 2 Net Profit / (Loss)	$20,000	$20,000	$0.00
Year 3 Net Profit / (Loss)	$30,000	$20,000	$10,000
Year 4 Net Profit / (Loss)	$40,000	$20,000	$20,000
Year 5 Net Profit / (Loss)	$50,000	$20,000	$30,000
Total Net Income			$50,000
Average Net Inome ($50,000/5)			$10,000

Calculation of Average rate of return :-

Average Rate of Return : Average Net Income*100 / Initial Outlay

Average Rate of Return : $10,000*100 / $1,00,000 = 10%

So Average rate of return is 10%.