Question

A new project has an initial cost of $190,000. The equipment will be depreciated on a straight-line basis to a book value of $77,000 at the end of the four-year life of the project. The projected net income each year is $15,900, $18,400, $24,000, and $15,800, respectively. What is the average accounting return?

Answer 1

Solution:

The Average accounting return is calculated using the formula

= Average Net Income / Average Investment

As per the Information given in the question we have

Net Income Year 1 : $ 15,900

Net Income Year 2 : $ 18,400

Net Income Year 3 : $ 24,000

Net Income Year 4 : $ 15,800

No. of years = 4

Thus Average Net income = ( Sum of Net Income earned from Year 1 to Year 4 ) / No. of years

= ( $ 15,900 + $ 18,400 + $ 24,000 + $ 15,800 ) / 4

= $ 74,100 / 4

= $ 18,525

Average Investment = ( Initial Book value + Book value at end of Year 4 ) / 2

= ( $ 190,000 + 77,000 )/ 2 = $ 267,000 / 2 = $ 133,500

Thus Average Accounting Return = Average Net Income / Average Investment

= $ 18,525 / $ 133,500 = 0.1388

= 13.88 %

Thus the Average accounting rate of return = 13.88 %