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Question 21.3: The accounting rate of return method Bridge Limited is consi...

The accounting rate of return method
Bridge Limited is considering investing in a new project, the details of which are as follows:

Project life 5 years
£000 £000
Project cost 50
Estimated net profit:
Year          1 12
2 18
3 30
4 25
5 \underline{5}
Total net profit \underline{\underline{90}}

The estimated residual value of the project at the end of Year 5 is £10 000.

Required:
Calculate the accounting rate of return of the proposed new project, using the two methods described above.

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The accounting rate of return would be calculated as follows:
(a) Using the initial capital employed:

\frac{\text{Average annual net profits}}{\text{Cost of the investment}} \times 100

Average annual net profits = £18 000 (£90 000/5)
∴ Accounting rate of return = \frac{£18 000}{50 000} \times 100=\underline{\underline{36 \%}}

(b) Using the average capital employed:

\frac{\text{Average annual net profits}}{\text{Average capital employed}} \times 100

 

= \frac{£18 000}{\frac{1}{2}(£50 000 + 10 000)} \times 100= \underline{\underline{60 \%}}

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