Question

Caldo Professional Movers is considering purchasing some new equipment costing $210,000. The equipment will be depreciated on a straight-line basis to a zero book value over the four-year life of the project. Projected net income for the four years are $7,200, $11,300, $14,100, and $20,000. What is the average accounting rate of return? Assume the required AAR is 12%, should we buy the new equipment?

Answer 1

Based on the projected net incomes and cost of purchasing the equipment, the average accounting rate of return is 12.5%.

How can we find the average accounting rate of return?

This can be found as:

= Average cashflows / Average investment

Average cashflows are:

= (7,200 + 11,300 + 14,100 + 20,000) / 4

= $13,150

Average investment is:

= 210,000 / 2

= $105,000

The average accounting rate of return is:

= 13,150 / 105,000

= 12.5%

The new equipment should not be bought if the required AAR is 12% because it would be less than the AARR.

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