Accounting Rate of Return Methods Flashcards
Yeager Company is considering several alternative capital investments. In evaluating the investments, management of the company has used the payback and accounting rate of return methods.
Prepare a memorandum to Linda Gordon, the chief financial officer, describing the limitations of these two methods for evaluating investments and suggesting other methods that might be more appropriate.
Payback method.
-Evaluates investments based on the length of time it takes to recapture the initial investment.
-Has two major limitations:
1. Ignores the overall profitability of the investment.
2. Does not take into account the time value of money.
Yeager Company is considering several alternative capital investments. In evaluating the investments, management of the company has used the payback and accounting rate of return methods.
Prepare a memorandum to Linda Gordon, the chief financial officer, describing the limitations of these two methods for evaluating investments and suggesting other methods that might be more appropriate.
Accounting Rate of Return
-Evaluates investment alternatives based on their rate of accounting return.
-Ignores the time value of money.
-Can result in choosing investments that may not result in maximization of the company’s return on investment.
Yeager Company is considering several alternative capital investments. In evaluating the investments, management of the company has used the payback and accounting rate of return methods.
Prepare a memorandum to Linda Gordon, the chief financial officer, describing the limitations of these two methods for evaluating investments and suggesting other methods that might be more appropriate.
Suggested alternative methods.
-NPV: evaluates investment alternatives based on the present values of the future cash flows of the investments.
-IRR: evaluates investment alternatives based on their time-adjusted rates of return.
-Both considers both the total profitability of the investment and the time value of money.
