Your firm is considering purchasing a machine which requires an annual investment of €16,000. Depreciation is calculated using 20 per cent reducing balance (i.e. instead of depreciating the machine by the same amount each year, we depreciate the residual value of the investment by 20 per cent).

The machine generates, on average, €4,500 per year in additional net income. Assume that the estimated economic life is 5 years.

(a) What is the average accounting return for this machine?

(b) What three flaws are inherent in this decision rule?