Question

Redwood Corporation is considering two alternative investment proposals with the following​ data: Proposal X Proposal Y Investment ​$900,000 ​$488,000 Useful life 9 years 9 years Estimated annual net cash inflows for 9 years ​$130,000 ​$84,000 Residual value ​$42,000 ​$minus Depreciation method Straightminusline Straightminusline Required rate of return ​15% ​12% What is the accounting rate of return for Proposal​ Y? (Round any intermediary calculations to the nearest​ dollar, and round your final answer to the nearest hundredth of a​ percent, X.XX%.)

Answer 1

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%