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Chapter 26: Q12RQ (page 1464)

What is the accounting rate of return?

Short Answer

Expert verified

Answer

ARR is calculated using accrual accounting rather than net cash inflows.

Step by step solution

01

Meaning Rate of return

A profit or any sum earned after making some investments is known as the rate of return. Current and original values are the amounts required to compute the rate of return.

02

Explaining the accounting rate of return

ARR is a technique that depicts the profitability of an investment. It shows the relation between the company's average annual operating incomes earned using the average amount invested or the initial investment.

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Most popular questions from this chapter

Explain the difference between capital assets, capital investments, and capital budgeting.

How is the present value of an annuity determined?

Using IRR to make capital investment decisions

Refer to the data regarding Hawkins Products in Exercise E26-25. Compute the IRR of each project, and use this information to identify the better investment.

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鈥檚 IRR. How does the IRR compare with the company鈥檚 requiredrate of return?

Henry Hardware is adding a new product line that will require an investment of \(1,512,000. Managers estimate that this investment will have a 10-year life and generate net cash inflows of \)310,000 the first year, \(270,000 the second year, and \)240,000 each year thereafter for eight years. Compute the payback period. Round to one decimal place.
See all solutions

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