Answer:
6.1%
Explanation:
As per given data
Proposal X Proposal Y
Investment $900,000 $488,000
Useful life 9 years 9 years
Annual net cash inflows for 9 years $130,000 $84,000
Residual value $42,000 $0
Depreciation method Straight-line Straight-line
Required rate of return 15% 12%
Accounting rate of return is the ratio of average net income of a project and the average investment made in the project.
Accounting rate of return = Average Net income / Average Investment
As net cash inflows are given we need to deduct the depreciation from the cash flows to arrive at the net income for the period. As all cash flows are constant so, the average value will be equal to the single years value.
Average net income = Net cash inflows - Depreciation = Net cash inflows - ( Cost of Asset - Residual value ) / Useful life of asset = $84,000 - ( $488,000 - $0) / 9 = $84,000 - $54,222 = $29,778
Average Investment = $488,000
Placing Values in the formula
Accounting rate of return = $29,778 / $488,000 = 6.1%
