I am having trouble with this problem. I have included the reference tables that

Question

I am having trouble with this problem. I have included the reference tables that we are required to use. I will also include notes from the book. There may be many ways to figure out the answers but the book requires us to use their methods. One tutor has tried to help me prior but they were unsuccessful. I am using the textbook: Kimmel, Accounting: Tools for Decision Making, 5e. This is a problem from Chapter 24 Planning Capital Investments. It is E24-11. Please note the text in red.

Question:

Notes:

Reference Tables:

Explanation / Answer

As per the textbook method given above:-

Annual Rate of Return = Expected Annual Net Income / Average Investment

Average Investment = (Original Investment + Value at the end of Useful life) / 2

Given Original Investment = $104,820 Salvage Value = 0

Average Investment = (104,820 + 0) / 2

Average Investment = $52,410

Annual Rate of Return

As we can see above the annual rate of return is greater than required rate of return of 12% therefore the project is acceptable.

Advantage of using this method is its simplicity of calculation. But the major limitation of this method is that it does not consider time value of money. For example no consideration is given to cash flows. Recognition of time value of money can make a significant difference between future cash flows and discounted present value of investment.Second disadvantage is it relies on accrual accounting rather than expected cash flows due to this we have considered annual net income instead of cash flows.

Year Expected Annual Net income/Average Investment Annual Rate of Return 1 9,970/52,410 19.02% 2 12,330/52,410 23.53% 3 14,480/52,410 27.63% 4 16,470/52,410 31.43% 5 17,030/52,410 32.49%

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