10.10) Average Accounting Rate of Return (ARR): Capitol Corp. management is expe
ID: 2700131 • Letter: 1
Question
10.10) Average Accounting Rate of Return (ARR): Capitol Corp. management is expecting a project to generate after-tax income of $63,435 in each of the next three years. The average book value of the project's equipment over that period will be $212,500. If the firm's acceptance decision on any project is based on an ARR of 37.5 percent, should this project be accepted?
10.16) Net Present Value: Emporia Mills Management is evaluating two alternative heating systems. Cost and projected energy savings are given in the following table. The firm uses 11.5 percent to discount such project cash flows. Which system should be chosen?
Year
System 100
System 200
0
$(1,750,000)
$(1,735,000)
1
$275,223
$750,000
2
$512,445
$612,500
3
$648,997
$550,112
4
$875,000
$384,226
Explanation / Answer
10.10)
Annual After Tax Income = 63,435
Average After Tax Income = (63,435 + 63,435 + 63,435)/3 = 63,435
Average Book Value Of Equipment = 212,500
Accounting Rate Of Return = Average after-Tax Income/Average book value = 63,435/212,500 = 29.9%
Since Project's ARR is below the acceptance rate of 37.5 percent ,the project should be rejected
10.16)
Required rate of return = 11.5%
System 100 :
Cost of production line expansion = 1,750,000
NPV = -1.750,000 + (275,223/1.115) -(512,445/1,115^2) + (648,997/1,115^3) + (875,000/1.11564)
= -56,667
System 200 :
Cost of production line expansion = 1,735,000
NPV = -1,735,000 + (750,00/1.115) - (612,500/1.115^2) + (550,112/1.115^3) + (384,226/1.115^4)
= 75,758
Since System 200 has positive NPV select that system
Since System 100 has negative NPV reject that system
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