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Describe Accounting Rate of Return (ARR) as a method of Investment Appraisal

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Definition:
ARR = the ratio of average profits, after depreciation, to the capital invested.
However, there are numerous variations and interpretations to this definition for the following reasons:
- Profits may be before or after tax.
- Capital invested may mean the initial capital investment or the average capital invested.
- Capital may or may not include working capital.
Calculation of ARR
Capital invested could be taken to mean either
(i) Initial capital, or
(ii) Average capital
Advantage:
(i) It is simple to calculate.
Disadvantages:
(i) Does not allow for timing of outflows and inflows. i.e. projects may be ranked equally even if there are clear differences in timings;
(ii) Uses as measure of return the concept of accounting profit. Profit has subjective element, is subject to accounting convention and is not as appropriate for investment appraisal purposes as the Cash flows generated by the project;
(iii) There is no universally accepted method of calculating ARR.

Titany answered the question on November 15, 2021 at 08:51

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