How to Calculate Accounting Rate of Return Example

Calculation Result

Average Investment: $0.00

Accounting Rate of Return: 0%

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What is Accounting Rate of Return (ARR)?

The Accounting Rate of Return (ARR) is a financial ratio used in capital budgeting to measure the profitability of an investment or project. Unlike other metrics like Net Present Value (NPV), ARR does not account for the time value of money. Instead, it focuses on the expected percentage return on an investment based on net accounting profit.

The ARR Formula

This calculator uses the Average Investment method, which is the most common industry standard for calculating ARR. The formulas applied are:

• Average Investment = (Initial Investment + Salvage Value) / 2
• ARR (%) = (Average Annual Net Profit / Average Investment) × 100

Step-by-Step ARR Example Calculation

Let's look at a realistic scenario for a small business owner considering a new piece of machinery:

1. Initial Investment: $100,000 for a new CNC machine.
2. Salvage Value: The machine can be sold for $20,000 after 5 years.
3. Net Profit: The machine is expected to generate a total net profit of $60,000 over 5 years.
4. Average Annual Profit: $60,000 / 5 years = $12,000 per year.

Step 1: Calculate Average Investment
($100,000 + $20,000) / 2 = $60,000

Step 2: Calculate ARR
($12,000 / $60,000) × 100 = 20%

Why Use ARR?

ARR is particularly useful for managers because it uses accounting data that is already readily available from income statements. It provides a simple percentage that can be easily compared against the company's required rate of return or "hurdle rate." If the calculated ARR exceeds the hurdle rate, the project is generally considered financially viable.

Note: While ARR is easy to calculate, it ignores the timing of cash flows. For more complex projects, it is often used alongside Internal Rate of Return (IRR) and Payback Period analysis.