Question

​O'Mally Department Stores is considering two possible expansion plans. One proposal involves opening 5 stores in Indiana at the cost of​ $1,810,000. Under the other​ proposal, the company would focus on Kentucky and open 6 stores at a cost of​ $2,000,000. The following information is​ available: Indiana proposal Kentucky proposal Required investment ​$1,810,000 ​$2,000,000 Estimated life 6 years 6 years Estimated residual value ​$80,000 ​$40,000 Estimated annual cash inflows over the next 10 years ​$700,000 ​$800,000 Required rate of return ​13% ​13% The accounting rate of return for the Indiana proposal is closest to​ (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:

O'Mally Department Stores

The accounting rate of return for the Indiana proposal is closest to 24.28%

Explanation:

a) Data and Calculations:

                                              Indiana proposal        Kentucky proposal

Required investment ​                  $1,810,000 ​                $2,000,000

Estimated life                                     6 years                        6 years

Estimated residual value                ​$80,000                       ​$40,000

Estimated depreciable cost       $1,730,000                  $1,960,000

Average depreciable cost            $288,333                    $326,667

Estimated annual cash inflows

 over the next 10 years ​              $700,000 ​                    $800,000

Average cash inflows                    $70,000                       $80,000

Required rate of return                    13%                               13%

Accounting rate of return = Average cash inflows/Average depreciable cost x 100 = $70,000/$288,333 x 100 = 24.28%

The Indiana proposal of O'Mally Department Stores' accounting rate of return is the ratio of estimated accounting profit to the average investment cost.  The estimated accounting profit is equivalent to the average cash inflow and the average investment cost is equivalent to the average depreciable cost.