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You are analyzing a capital project. It passes the Payback threshold of your company. So, if...

You are analyzing a capital project. It passes the Payback threshold of your company. So, if the accounting rate of return exceeds the companies’ required rate of return, you would recommend:

A) invest in the capital asset.

B) do not invest in the capital asset.

C) only invest if the payback period is also greater than the required rate of return.

D) only invest if the payback period is also less than the required rate of return.

Business   Accounting   
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Answer #1

A - Invest in the capital project

Accounting rate of return is the estimated rate of profit of a project to the average investment made in the project. It is the expected percentage of return from the investment.

The formula is ARR = Average Annual Profit / Average Investment.

If ARR is 5% it means that the project is expected to earn five percentage of its investement for the period.

On the other hand required rate of return (RRR) is the minimum rate of return an investor could accept for investing in  a project. It is the desired rate of return an investor could expect to receive for a capital investment of acomparable risk.

If the ARR of a project is greater than it's RRR it means that the project would earn a profit over and above investors' expectations.

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