Average Accounting Rate of Return (ARR)

Average Accounting Rate of Return is a technique that measures the profitability of a project using the accounting profits of the company. ARR is the average net income expected by a project divided by the average capital cost. ARR is also known as the Average Rate of return or Simple Rate of Return.

Where,
Average Net Profit = Total Profit in Investment /Number of years
Average Investment
  • ARR is a tool used in Capital budgeting to evaluate the returns of various investments by using accounting profits instead of cash flows.
  • ARR ignores the Time Value of Money.
  • A Project is assumed to be profitable if ARR >= Expected Rate of Return.
Example 1: ABC Ltd. has initially invested Rs. 500000.00 in a project with the following cash flow, calculate the ARR of the project.
Year 1 2 3 4
Net Profit 110000.00 125000.00 135000.00 150000.00
Solution:
Average Net Profit = (110000 + 125000 + 135000 + 150000) / 4 = 520000 / 4 = 130000.00
Average Investment = (500000 – 0) / 2 = 250000
ARR = Average Net Profit / Average Investment = 130000 / 250000 = 0.52
Hence, ARR = 0.52 or 52%
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