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Chapter 26: Q14RQ (page 1464)

What is the decision rule for ARR?

Short Answer

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Answer

If the ARR achieves or exceeds the statutory accounting rate of return, the project is only acknowledged.

Step by step solution

01

Meaning of ARR

Theeffect of the investment on the company's accrual-based income is depicted by the ARR. Rather than using the net inflow of cash and its predictions, the accounting rate of return primarily employed accrual accounting.

02

Decision rule for ARR

The accounting rate of return decision rule is:

Invest if the predicted accounting rate of return matches or exceeds the necessary rate of return. Do not invest if the rate of return is less than the needed rate of return.

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Most popular questions from this chapter

What is the decision rule for NPV?

Howard Company operates a chain of sandwich shops. The company is considering two possible expansion plans. Plan A would open eight smaller shops at a cost of \(8,500,000. Expected annual net cash inflows are \)1,600,000 for 10 years, with zero residual value at the end of 10 years. Under Plan B, Howard Company would open three larger shops at a cost of \(8,100,000. This plan is expected to generate net cash inflows of \)1,000,000 per year for 10 years, which is the estimated useful life of the properties. Estimated residual value for Plan B is $990,000. Howard Company uses straight-line depreciation and requires an annual return of 6%.

Requirements

1. Compute the payback, the ARR, the NPV, and the profitability index of these two plans.

2. What are the strengths and weaknesses of these capital budgeting methods?

3. Which expansion plan should Howard Company choose? Why?

4. Estimate Plan A’s IRR. How does the IRR compare with the company’s required rate of return?

Henry Co. is considering acquiring a manufacturing plant. The purchase price is \(1,200,000. The owners believe the plant will generate net cash inflows of \)325,000 annually. It will have to be replaced in six years. Use the payback method to determine whether Henry should purchase this plant. Round to one decimal place.

Match the following business activities to the steps in capital budgeting process.

Steps in the capital budgeting process:

a. Develop strategies

b. Plan

c. Direct

d. Control

Business activities:

1. A manager evaluates progress one year into the project.

2. Employees submit suggestions for new investments.

3. The company builds a new factory.

4. Top management attends a retreat to set long-term goals.

5. Proposed investments are analyzed.

6. Proposed investments are ranked.

7. New equipment is purchased.

Explain the difference between the present value factor tables—Present Value of \(1 and Present Value of Ordinary Annuity of \)1.
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