Accounting Rate of Return (ARR)
ARR provides a quick estimate of a project's worth over its useful life. ARR is derived by finding profits before taxes and interest. ARR is an accounting method used for purposes of comparison. The major drawbacks of ARR are that it uses profit rather than cash flows, and it does not account for the time value of money.

ARR is most often used internally when selecting projects. It can also be used to measure the performance of projects and subsidiaries within an organisation. Various proposals are ranked in order to rate of earnings on the investment in the projects concerned. The project which shows highest rate of return is selected and others are ruled out.

How to calculate ARR
The Accounting rate of Return is found out by dividing the average income after taxed by the average investment, i.e., average net value after depreciation. The accounting rate of return, thus, is an average rate and can be determined by the following equation.

Accounting Rate of Return (ARR) = Average income / Average investment Average rate of Return= Estimated average annual income
Average investment
Average investment is original investment divided by 2
Advantage of ARR
1) Easy to calculate
2) Fairly easy to construct (realistic) examples
Disadvantage of ARR
1) Cash flows are more important to investors, and ARR is based on numbers that include non-cash items. 2) ARR does not take into account the time value of money — the value of cash flows does not diminish with time as is the case with NPV and IRR. 3) It does not adjust for the greater risk to longer term forecasts. 4) There are better alternatives which are not significantly more difficult to calculate.

Project A:
Average annual net income = ($225,000 + $225,000 + $225,000)/3 = $225,000
Average investment = ($600,000 + $0)/2
= $300,000
Average accounting return = $225,000/$300,000...

...Internal Rate of Return
Meaning of Capital Budgeting
Capital budgeting can be defined as the process
of analyzing, evaluating, and deciding whether
resources should be allocated to a project or
not.
Capital budgeting addresses the issue of
strategic long-term investment decisions.
Process of capital budgeting ensure optimal
allocation of resources and helps management
work towards the goal of shareholder wealth
maximization.
Why Capital...

...Accountingrate of return
The accountingrate of return (ARR) is a way of comparing the profits you expect to make from an investment to the amount you need to invest.
The ARR is normally calculated as the average annual profit you expect over the life of an investment project, compared with the average amount of capital invested. For example, if a project requires an average...

...INTERNAL RATE OF RETURN
Many companies wants to have a return on their investment in a few years and begin to evaluate their projects optimistically calculating an internal rate of real return not yielding results in the end. This does not end up being expected by the companies; According to the article the authors John C. Kelleher and Justin J. MacCormack . They suggest that there is a tendency to a risky behavior,...

...Internal Rate of Return
In investment decision analysis you may need to calculate internal rate of return. “Internal rate of return (IRR) is the discount rate that gives the project a zero NPV” (McLaney, 2006). It is a good choice to use for investment projects. There is a formula for the internal rate of return:
(A is the lower discount rate and...

...Internal Rate of Return
Internal Rate of Return (IRR)
Calculation of the true interest yield expected from an investment. Explanation of Internal Rate of Return. What is Internal Rate of Return? Definition The Internal Rate of Return (IRR) is the discount rate that delivers a net present value of zero for a series of future cash flows....

...Accountingrate of returnAccountingrate of return (also known as simple rate of return) is the ratio of estimated accounting profit of a project to the average investment made in the project. ARR is used in investment appraisal.
Formula
AccountingRate of Return is calculated using the following formula:...

...000 | -$2,000,000 |
1 | 500,000 | |
2 | 500,000 | |
3 | 500,000 | |
4 | 500,000 | |
5 | 500,000 | |
6 | 500,000 | |
7 | 500,000 | 5,650,000 |
a. Compute the NPV and IRR for the above two projects, assuming a 13% required rate of return.
b. Discuss the ranking conflict.
c. What decision should be made regarding these two projects?
Answer:
a. NPV of A = $211,305 NPV of B = $401,592.64
IRR of A = 16.33% IRR of B = 15.99%...

...ch10
Student: ___________________________________________________________________________
1.
The capital gains yield plus the dividend yield on a security is called the:
A. geometric return.
B. average period return.
C. current yield.
D. total return.
2.
The expected return on a security in the market context is:
A. a negative function of execs security risk.
B. a positive function of the beta.
C. a negative function...

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