Book rate of return is an unsatisfactory guide to selecting capital projects because

I. It uses accrual accounting numbers.

II. It compares a single project against the average of capital projects.

III. It uses cash flows to gauge the desirability of the project.

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.