Understanding Accounting Rate of Return (ARR)

If a company is looking to project the expected return on an investment, it can use accounting rate of return. ARR is expressed as a percentage.

Calculating Accounting Rate of Return

The accounting rate of return (ARR) is a formula that measures the net profit, or return, expected on an investment compared to the initial cost. It is calculated by dividing the average annual profit by the initial investment cost and expressing the result as a percentage.

ARR Pros and Cons

The accounting rate of return has several advantages and disadvantages. On the one hand, it provides a simple and easy-to-understand measure of the profitability of an investment. It also takes into account the time value of money and provides a percentage return that can be compared to other investments. However, it does not consider the timing of cash flows, the length of the investment period, or the risk associated with the investment.

Bottom Line

The accounting rate of return is a useful tool for companies to evaluate the profitability of potential investments. However, it should be used in conjunction with other financial metrics and considerations to make well-informed investment decisions.

Tips for Evaluating Capital Investments

When evaluating capital investments, it is important to consider various factors to make informed decisions. Some tips for evaluating capital investments include:

• Consider the expected return on investment
• Assess the risk associated with the investment
• Evaluate the timing of cash flows
• Take into account the length of the investment period
• Consider the company's overall financial goals and objectives

By considering these factors, companies can make more informed decisions when evaluating potential capital investments.