Question

Consider the following statements about the accounting rate of return: I. The accounting rate of return...

Consider the following statements about the accounting rate of return: I. The accounting rate of return focuses on a project's income rather than its cash flows. II. Companies can figure the accounting rate of return on either the initial investment figure or an average investment figure. III. The accounting rate of return considers the time value of money. Which of the above statements is (are) correct?

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Answer #1

Statement I and II is correct

Accounting rate of return takes into consideration net income in computation of rate of return. It ignores the cash flows of the project. The net income is taken as per income statement after deducting depreciation expense and income taxes. The accounting rate of return can be calculated based on initial investment or average investment. Average investment is opening investment plus salvage value divided by 2. Accounting rate of return ignores the time value of money as it does not consider the cash flows and there is no cost of capital used in discounting the future cash flows to its present value. Hence Statement 1 and 2 are true.

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