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78106_10_Web_Ch10A_p01-02 - WEB EXTENSION The Accounting...

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W E B E X T E N S I O N 10A The Accounting Rate of Return (ARR) T his Web extension describes the accounting rate of return (ARR), which focuses on a project s net income rather than its cash flow. The ARR calculation is il- lustrated in Figure 10A-1. In its most commonly used form, the ARR is mea- sured as the ratio of the project s average annual expected net income to its average investment. If we assume that Projects S and L, as described in Chapter 10, will both be depreciated by the straight-line method to a book value of zero, then each will have a depreciation expense of $10,000/4 = $2,500 per year. The average cash flow minus the average depreciation charge is the average annual income. For Project S, average annual income is $750: Average annual income ¼ Average cash flow - Average annual depreciation ¼ ½ð $5 ; 000 þ $4 ; 000 þ $3 ; 000 þ $1 ; 000 Þ = 4 ± $2 ; 500 ¼ $750 The average investment is the beginning investment plus the ending investment (the salvage value), divided by 2, or $5,000: Average investment ¼ ð Cost þ
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