Question

3. A project has an initial cost of $30,000 and a 3-year life. The company uses straight-line depreciation to a book value of zero over the life of the project. The projected average net income from the project is $1,766.67 per year for the next 3 years, respectively. What is the accounting rate of return based on average investment?

A. 11.78 percent

B. 14.69 percent

C. 8.72 percent

D. 11.04 percent

4. You are considering two mutually exclusive projects with the following cash flows. Which project(s) should you accept if the discount rate is 8.5 percent? What if the discount rate is 13 percent?

Year Project A Project B
0 -$80,000 -$80,000
1 31,000 0
2 31,000 0
3 31,000 110,000
A. accept project B as it always has the higher NPV

B. accept B at 8.5 percent and neither at 13 percent

C. accept project A as it always has the higher NPV

D. accept A at 8.5 percent and B at 13 percent

Answer 1

1)

Average investment = (30,000 - 0) / 2

Average investment = 15,000

Accounting rate of return = (Average income / average investment) * 100

Accounting rate of return = (1,766.67 / 15,000) * 100

Accounting rate of return = 11.78 percent

2)

NPV = Present value of cash inflows - present value of cash outflows

NPV of project A at 8.5% = -80,000 + 31,000 / (1 + 0.085)¹ + 31,000 / (1 + 0.085)² + 31,000 / (1 + 0.085)³

NPV of project A at 8.5% = -825.31

NPV of project A at 13% = -80,000 + 31,000 / (1 + 0.13)¹ + 31,000 / (1 + 0.13)² + 31,000 / (1 + 0.13)³

NPV of project A at 13% = -6,804.269

NPV of project B at 8.5% = -80,000 + 11,000 / (1 + 0.085)³

NPV of project B at 8.5% = 6,119.89

NPV of project B at 13% = -80,000 + 31,000 / (1 + 0.13)¹ + 31,000 / (1 + 0.13)² + 31,000 / (1 + 0.13)³

NPV of project B at 13% = -3,764.48

B. accept B at 8.5 percent and neither at 13 percent