Calculation of Accounting Rate of Return

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What is the Accounting Rate of Return (ARR)?

The Accounting Rate of Return (ARR) is a profitability metric used in capital budgeting to evaluate the potential profitability of an investment. It measures the average profit an asset is expected to generate over its lifespan, expressed as a percentage of the initial investment.

How to Calculate ARR:

The formula for ARR is:

ARR = (Average Annual Net Income / Initial Investment) * 100

  • Initial Investment: This is the total cost incurred to acquire or set up the asset or project.
  • Average Annual Net Income: This is the expected profit after all expenses (including depreciation and taxes) have been deducted, averaged over the expected life of the investment.

A higher ARR generally indicates a more desirable investment, as it suggests that the project will generate more profit relative to its cost.

When to Use ARR:

ARR is a simple and widely used method for initial screening of investment projects. It's particularly useful for comparing the profitability of different investment opportunities when simplicity is preferred. However, it's important to note that ARR does not consider the time value of money, unlike other metrics such as Net Present Value (NPV) or Internal Rate of Return (IRR).

Example Calculation:

Suppose a company is considering investing in new machinery. The initial investment required is $50,000. The machinery is expected to generate an average annual net income of $10,000 over its useful life.

Using the ARR formula:

ARR = ($10,000 / $50,000) * 100 = 0.20 * 100 = 20%

This means the investment is expected to yield a 20% return based on its accounting profit.

function calculateARR() { var initialInvestment = parseFloat(document.getElementById("initialInvestment").value); var annualNetIncome = parseFloat(document.getElementById("annualNetIncome").value); var resultDiv = document.getElementById("result"); if (isNaN(initialInvestment) || isNaN(annualNetIncome) || initialInvestment <= 0) { resultDiv.innerHTML = "Please enter valid positive numbers for both fields."; return; } var arr = (annualNetIncome / initialInvestment) * 100; resultDiv.innerHTML = "

Accounting Rate of Return (ARR)

Your ARR is: " + arr.toFixed(2) + "%"; }

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