QUESTION A
(i) The accounting rate of return, based on the average investment.
Accounting rate of return is also known as Return on Capital Employed (ROCE)
Accounting Rate of Return/ ROCE = Average annual accounting profit × 100
Average Investment
Average annual accounting profit = Total Cash Profit – Total Depreciation cost
No of years
Total Cash Profit = (€2,000,000 × 3 years) + 1 million
= €7,000,000
Total Depreciation Cost = Investment Cost – Residual Value
= €5,000,000 – 0*
= €5,000,000
*Residual Value is 0 because the building is expected to yield at no residual value.
Average Annual Accounting Profit = €7,000,000– €5,000,000
4years
= €500,000 per year.
Average investment = Initial Investment + Residual Value
2 years
= €5,000,000 + 0
2 years
= €2,500,000
Therefore,
Accounting Rate of Return / ROCE = €500,000 × 100
€2,500,000
= 20 %
The decision rule of ROCE is to accept an investment project if its ROCE is greater than a target or hurdle rate of ...