Question : 11) The accrual accounting rate-of-return method has a significant weakness : 1211984

 

11) The accrual accounting rate-of-return method has a significant weakness for use in making capital budgeting decisions because it does NOT track cash flows and it ignores the time value of money.

12) As cash flows and time value of money are central to capital budgeting decisions, the AARR method is regarded as better than the IRR method.

 

13) Unlike the payback method, which ignores cash flows after the payback period, the AARR method considers income earned throughout a project’s expected useful life.

 

14) Gavin and Alex, baseball consultants, are in need of a microcomputer network for their staff. They have received three proposals, with related facts as follows:

 

 

Proposal A

Proposal B

Proposal C

Initial investment in equipment

$90,000

$90,000

$90,000

Annual cash increase in operations:

 

 

 

   Year 1

80,000

45,000

90,000

   Year 2

10,000

45,000

0

   Year 3

45,000

45,000

0

Salvage value

0

0

0

Estimated life

3 yrs

3 yrs

1 yr

 

The company uses straight-line depreciation for all capital assets.

 

Required:

a.Compute the payback period, net present value, and accrual accounting rate of return with initial investment, for each proposal. Use a required rate of return of 14%.

 

b.Rank each proposal 1, 2, and 3 using each method separately. Which proposal is best? Why?

 

15) Gibson Manufacturing is considering buying an automated machine that costs $600,000. It requires working capital of $60,000. Annual cash savings are anticipated to be $280,200 for five years. The company uses straight-line depreciation. The salvage value at the end of five years is expected to be $24,000. The working capital will be recovered at the end of the machine’s life.

 

Required:

Compute the accrual accounting rate of return based on the initial investment.

 

16) What are the four alternative methods for evaluating capital budgeting projects? What is an advantage and disadvantage of each method?

17) Bock Construction Company is considering four proposals for the construction of new loading facilities that will include the latest in ship loading/unloading equipment. After careful analysis, the company’s accountant has developed the following information about the four proposals:

 

 

Proposal 1

Proposal 2

Proposal 3

Proposal 4

Payback period

4 years

4.5 years

6 years

7 years

Net present value

$80,000

$178,000

$166,000

$308,000

Internal rate of return

12%

14%

11%

13%

Accrual accounting rate of return

8%

6%

4%

7%

 

Required:

How can this information be used in the decision-making process for the new loading facilities? Does it cause any confusion?

 

18) What are the strengths and weaknesses of the accrual accounting rate-of-return (AARR) method for evaluating long-term projects?

 

 

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