Accounting Rate of Return

WeCare Clinic is planning on investing in some new echocardiogram equipment that will require an initial outlay of $155,000. The system has an expected life of five years and no expected salvage value. The investment is expected to produce the following net cash flows over its life: $71,000, $78,000, $81,000, $82,000, and $106,000.

Required:

1. Calculate the annual net income for each of the five years.

	Net Income
Year 1	$fill in the blank 1
Year 2	$fill in the blank 2
Year 3	$fill in the blank 3
Year 4	$fill in the blank 4
Year 5	$fill in the blank 5

2. Calculate the accounting rate of return. Enter your answer as a whole percentage value (for example, 16% should be entered as "16").

3. What if a second competing revenue-producing investment has the same initial outlay and salvage value but the following cash flows (in chronological sequence): $106,000, $106,000, $106,000, $71,000, and $14,500? Calculate its accounting rate of return. Enter your answer as a whole percentage value (for example, 16% should be entered as "16'

Using the accounting rate of return metric, which project should be selected: the first or the second? First project

Why might the second project be preferred over the first project? It returns larger amounts of cash sooner than the first project

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1. Remember net income is on an accrual basis. It is not the same as annual cash flow.

2. The accounting rate of return measures the return on a project in terms of accrual based income as opposed to using a project's cash flow.

3. Remember to factor depreciation expense into the calculation of average net income.

See Example 19.2

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