26-2a Average Rate of Return Method The average rate of return, sometimes called the accounting rate of return, measures the average income as a percent of the average investment. The average rate of return is computed as follows: Average Rate of Return Estimated Average Annual Income Average Investment In the preceding equation, the numerator is the average of the annual income expected to be earned from the investment over its life, after deducting depreciation. The denominator is the average investment (book value) over the life of the investment. Assuming straight-line depreciation, the average investment is computed as follows: Average Investment = Initial Cost + Residual Value 2 To illustrate, assume that management is evaluating the purchase of a new machine as follows: Cost of new machine Residual value Estimated total income from machine Expected useful life $500,000 $0 $200,000 4 years