140
Business Finance (ACC501)
Lesson 27
Review of the Previous Lecture
•
Net Present Value
–
Estimating NPV
–
Using NPV
•
The Payback Rule
–
Advantages and Disadvantages
Topics under Discussion
•
Average Accounting Return
•
Internal Rate of Return
–
Problems with IRR
Average Accounting Return
•
It is defined as:
Some measure of average accounting profit
Some measure of average accounting value
•
Specifically:
Average net income
Average book value
•
Suppose we are deciding whether or not to open a store in a new shopping center.
•
The required investment in improvements is $500,000
•
The store has a 5-years life, as everything reverts to the owners of the shopping
center after that time.
•
The required investment would be 100% depreciated over 5 years, i.e.
$500,000 / 5 = $100,000 per year
•
Tax rate is 25%
Average Accounting Return
Year 1
Year 2
Year 3
Year 4
Year 5
Revenue
$433,333 $450,000 $266,667
$200,000
$133,333
Expenses
200,000
150,000
100,000
100,000
100,000
Earnings before
depreciation
$233,333
$300,000 $166,667
$100,000
$
33,333
Depreciation
100,000
100,000
100,000
100,000
100,000
Earnings before
taxes
$133,333
$200,000 $
66,667
$
0
-$
66,667