Page 309 - SBL Integrated Workbook STUDENT 2018

Financial decision making

Investment appraisal

5.1 Accounting rate of return

The Accounting Rate of Return (ARR) calculates a percentage return
provided by the accounting profits of the project.

Average annual profit
ARR =
Average value of investment

 The average annual profit is net cash flow, less depreciation

 The average value of the investment represents the average
capital employed over the life of the project

 Average value of investment =

Initial investment plus residential value
2

 The ARR for a project may be compared with the company’s
target return and if higher the project should be accepted.

 Faced with a choice of mutually-exclusive investments, the project
with the highest ARR should be chosen, provided it meets the
company’s target return.

Suitability This is best for short projects where there are clear financial accounting
targets (perhaps if a financial control parenting style is being used).

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