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416 Corporate Finance BRILLIANT’S

CAPITAL BUDGETING: AVERAGE RATE OF RETURN (ARR) METHOD
H¡${nQ>b ~OqQ>J: [aQ>Z© H$m EdaoO aoQ> (ARR) ‘oWS>

Q.48. Write a short note on Average Rate of Return (ARR).
[aQ>Z© Ho$ EdaoO> aoQ> (ARR) na g§{já {Q>ßnUr {b{IE&
OR
How do you take decision under ARR method? Write its merits and demerits.
ARR {d{Y Ho$ A§VJ©V Amn {ZU©¶ H¡$go b|Jo? BgHo$ JwU VWm Xmof {b{IE&

Average Rate of Return (ARR) OR Ac- EdaoO aoQ> Am°\$ [aQ>Z© (ARR) `m AH$mCpÝQ>¨J
counting Rate of Return or Unad- aoQ> Am°\$ [aQ>Z© `m AZES>OñQ>oS> aoQ> Am°\$ [aQ>Z©
justed Rate of Return
Average rate of return or Accounting rate EdaoO aoQ> Am°\$ [aQ>Z© `m AH$mCpÝQ>¨J aoQ> Am°\$
of return means the average annual earning on [aQ>Z© H$m AW© àmoOoŠQ> go àmßV Am¡gV dm{f©H$ Am` h¡Ÿ& Bg
the project. Under this method, profit after tax nÕ{V Ho$ A§VJ©V Q>¡Šg níMmV² cm^ Ed§ S>o{à{gEeZ H$mo
and depreciation as percentage of total invest- Hw$c BÝdoñQ>_|Q> Ho$ à{VeV Ho$ ê$n _| {c`m OmVm h¡Ÿ& AÝ`
ment is considered. In other words, the annual
eãXmo§ _|, àmoOoŠQ> H$m dm{f©H$ [aQ>Z©, àmoOoŠQ> _| {H$E JE
returns of a project are expressed as a percent-
age of the net investment in the project.· Hw$c BÝdoñQ>_|Q> Ho$ à{VeV Ho$ ê$n _| Xem©`m OmVm h¡Ÿ&
Calculation of ARR ARR H$s JUZm
The average rate of return can be calcul- EdaoO aoQ> Am°\$ [aQ>Z© H$s JUZm {ZåZ{b{IV Xmo
ated in the following two ways: VarH$m| go H$s OmVr h¡:
(i) ARR on Initial Investment: (i) ewê$dmVr BÝdoñQ>‘|Q> na ARR:

Average Profit After Tax
× 100
Initial Investment
In this case, the original cost of investment Bg Ho$g _|, BÝdoñQ>_|Q> H$m dmñV{dH$ H$m°ñQ> VWm
and the installation expenses if any, is taken as B§ñQ>m°coeZ H$m ì``, `{X H$moB© hmo Vmo Cgo àmoOoŠQ> _|
the amount invested in the project. To calculate BÝdoñQ> H$s JB© am{e _mZr OmVr h¡& EdaoO àm°{\$Q> H$s JUZm
average profit after tax, total profit after tax is Ho$ {bE S>o{à{gEeZ Ed§ Q>¡Šg Ho$ níMmV² Ho$ Hw$b bm^ H$mo
divided by the number of years of the project. àmoOoŠQ> H$s Ad{Y Ho$ dfm] go {d^m{OV {H$`m OmVm h¡Ÿ&
Theoretically this approach seems to be g¡Õm§{VH$ ê$n go, `h {dMma C{MV {XIVm h¡ naÝVw
good but taking the initial investment as the àma§{^H$ BÝdoñQ>_|Q> H$mo EdaoO aoQ> Am°\$ [aQ>Z© H$r JUZm Ho$
base of calculating average rate of return is not
correct on logical ground. {bE AmYma ~ZmZm VH©$g§JV Zht hmoVm h¡Ÿ&
(ii) ARR on Average Investment: (ii) Am¡gV BÝdoñQ>‘|Q> na ARR:

Average Profit After Tax
× 100
Average Investment