Answer (B) is correct . A common misstep in regard to capital budgeting is the temptation to gauge the desirability of a project by using accrual accounting numbers instead of cash flows. Net income and book value are affected by the company’s choices of accounting methods. A project’s true rate of return cannot be dependent on bookkeeping decisions. Another distortion inherent in comparing a single project’s book rate of return to the current one for the company as a whole is that the latter is an average of all of a firm’s capital projects. Embedded in that average number may be a handful of good projects making up for a large number of poor investments.
Answer (A) is incorrect because The comparison of a single project’s book rate of return against an average of all of a firm’s capital projects is also a reason that book rate of return is an unsatisfactory guide.
Answer (C) is incorrect because The book rate of return does not use cash flows in determining the desirability of a capital project.
Answer (D) is incorrect because Book rate of return does not utilize cash flows in the determination.
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