Chapter 25, Problem 1DQ

To determine

Average Rate of Return:

Average rate of return is a method that measures the average earnings of a particular business, as a percentage of the average investment. It is also known as accounting rate of return.

Calculation of Average rate of return:

$\text{Average}\text{Rate}\text{of}\text{Return}\}\text{=}\frac{\left(\text{Estimated}\text{Average}\text{Annual}\text{Income}\right)}{\left(\text{Average}\text{Investment}\right)}\text{}\times 100$

The principal objection to use the average rate of return method.

Explanation of Solution

The major objection for using the average rate of return method is as follows:

1. Average rate of return method doesn’t consider the expected cash flows from the investment proposals.

2. It also doesn’t consider the period (timing) of the expected cash flows.