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Investment appraisal techniques

The 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 residual 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.

Illustrations and further practice

Now attempt example 8 ‘Mickey Continued’ from Chapter 10.

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