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418 Corporate Finance BRILLIANT’S

Merits JwU
1. This method is very simple and popular. 1. `h EH$ gab Ed§ bmoH${à` _oWS> h¡Ÿ&
2. It is very easy to understand the income 2. Bg nÕ{V go àmoOoŠQ> go hmoZo dmbr BÝH$_ H$s JUZm
from the project. H$aZm AmgmZ h¡Ÿ&
3. ARR can be readily calculated from the 3. ARR H$s JUZm AH$mCpÝQ>¨J S>mQ>m go gabVm go H$s
accounting data. No adjustments are Om gH$Vr h¡Ÿ& NPV VWm IRR H$s Vah H¡$e âbmo
required to arrive at cash flow of the na nh±wMZo Ho$ {bE {H$gr ES>OñQ>_|Q> H$s Amdí`H$Vm
project like in NPV and IRR.
Zht hmoVr h¡Ÿ&
4. Unlike the pay-back period, the ARR 4. no-~¡H$ nr[a`S> Ho$ {dnarV, ARR _| àmoOoŠQ> H$s
considers all the benefits arising out of the nyar Ad{Y _| {_bZo dmbo bm^m| H$mo gpå_{bV {H$`m
proposal throughout its economic life. OmVm h¡Ÿ&

Demerits Xmof
No doubt, the ARR is a commonly used ¶Ú{n EdaoO aoQ> Am°\$ [aQ>Z© _oWS> bmoH${à` Ed§
method and easy to apply by accountants. But, AH$mCÝQ>|Q²>g Ûmam Cn`moJ H$aZo _| gac h¡Ÿ& naÝVw {S>{gOZ
as a decision criterion, it has some serious g§~§Yr EH$ _mZX§S> Ho$ ê$n _| Bg_| Hw$N> H${_`m± h¢, Omo
shortcomings which are as follows:
{ZåZ{b{IV h¢:
1. It ignores the time value of money and 1. `h _oWS> _Zr Ho$ Q>mB_ d¡ë`y H$s Cnojm H$aVr h¡ VWm
considers the profit earned in the first year
`h àW_ df© _| àmá cm^ H$mo ~mX Ho$ dfm] _| àmá hþE
as equal to the profit earned in later years.
The future profit is not discounted which cm^ Ho$ ~am~a _mZVr h¡Ÿ& ^{dî` Ho$ cm^ H$mo {S>ñH$mC§Q>
is very important in capital budgeting Zht {H$`m OmVm h¡ Omo H¡${nQ>c ~OqQ>J {ZU©` _|
decisions. _hËdnyU© h¡Ÿ&
2. The accounting rate of return is based on 2. [aQ>Z© H$m AH$mCpÝQ>¨J aoQ>, H¡$e âcmo Ho$ ~Xco AH$mCpÝQ>¨J
accounting profits rather than the cash àm°{\$Q> na AmYm[aV hmoVm h¡Ÿ& gm_mÝ`V… `h _mZm
flows. It is generally accepted that a sound OmVm h¡ {H$ àmoOoŠQ> Ho$ _yë`m§H$Z H$m R>mog VarH$m,
technique of project evaluation should be
based on the cash flows rather than the AH$mCpÝQ>¨J àm°{\$Q²>g Ho$ ~Xco H¡$e âcmoO na AmYm[aV
accounting profits. hmoZm Mm{hEŸ&
3. The ARR also ignores the life of the 3. ARR, àmoOoŠQ> H$s Ad{Y na ^r Ü`mZ Zht XoVr h¡Ÿ&
proposal. A project with a longer life may {H$gr c§~o g_` Ho$ àmoOoŠQ> H$m ARR, H$_ g_` Ho$
have the same ARR as another project with
àmoOoŠQ> Ho$ g_mZ hr hmo gH$Vm h¡Ÿ& `{X ARR EH$
a shorter life. If ARR is taken same, both
the project would be placed at the same g_mZ {c`m OmVm h¡ Vmo XmoZm| àmoOoŠQ> H$mo g_mZ ñVa
level, while the project with a longer life na aIm OmEJm O~{H$ c§~o g_` Ho$ àmoOoŠQ> H$mo
should be preferable. The ARR method
àmW{_H$Vm Xr OmZr Mm{hEŸ& ARR _oWS> Eogo Xmo
fails to distinguish between such two
projects. àmoOoŠQ²>g Ho$ ~rM A§Va H$aZo _| Ag\$c hmo OmVr h¡Ÿ&
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