Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 26: Q3SE (page 1465)

Using accounting rate of return to make capital investment decisions

Carter Company is considering three investment opportunities with the following accounting rates of return:

Project X

Project Y

Project Z

ARR

13.25%

6.58%

10.47%

Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company’s required rate of return is 8%.

Short Answer

Expert verified

Rank

Project

1

X

2

Z

3

Y

Step by step solution

01

Definition of Accounting Rate of Return

The return percentage calculated under capital budgeting using the net income generated and the initial investment made is known as the accounting rate of return. It does not take into consideration the time value of money.

02

Ranking of projects

  1. Project X is given 1st rank because it represents the highest accounting rate of return and is, therefore, the most desirable.
  2. Project Z is given 2nd rank because it represents an accounting rate of return lower than project X but higher than project Y.
  3. Project Y is the least desirable because this project's accounting rate of return is lower than the required rate of return.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

Hicks Company is considering an investment opportunity with the following expected net cash inflows: Year 1, \(235,000; Year 2, \)195,000; Year 3, \(125,000. The company uses a discount rate of 6%, and the initial investment is \)365,000. Calculate the NPV of the investment. Should the company invest in the project? Why or why not?

John Johnson is the majority stockholder in Johnson’s Landscape Company, owning 52% of the company’s stock. John asked his accountant to prepare a capital investment analysis to purchase new mowers. John used the analysis to persuade a loan officer at the local bank to loan the company $100,000. Once the loan was secured, John used the cash to remodel his home, updating the kitchen and bathrooms, installing new flooring, and adding a pool.

Requirements

1. Are John’s actions fraudulent? Why or why not? Does John’s percentage of ownership affect your answer?

2. What steps could the bank take to prevent this type of activity?

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?

Hill 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\(8,700,000. Expected annual net cash inflows are \)1,550,000 for 10 years, with zeroresidual value at the end of 10 years. Under Plan B, Hill Company would open threelarger shops at a cost of \(8,340,000. This plan is expected to generate net cash inflowsof \)990,000 per year for 10 years, the estimated useful life of the properties. Estimatedresidual value for Plan B is $1,200,000. Hill Company uses straight-line depreciationand requires an annual return of 10%.

Requirements

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

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

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

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

Cornell Company is considering a project with an initial investment of \(596,500 that is expected to produce cash inflows of \)125,000 for nine years. Cornell’s required rate of return is 12%.

14. What is the NPV of the project?

15. What is the IRR of the project?

16. Is this an acceptable project for Cornell?
See all solutions

Recommended explanations on Business Studies Textbooks

Nature of Business

Read Explanation

Corporate Finance

Read Explanation

Change Management

Read Explanation

Managerial Economics

Read Explanation

Organizational Behavior

Read Explanation

Financial Performance

Read Explanation
View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free