How to Calculate Average Investment in Accounting Rate of Return

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Average Investment Calculator (ARR)

Determine the denominator for your Accounting Rate of Return calculations.

Estimated Average Investment: $0.00

How to Calculate Average Investment in Accounting Rate of Return

In capital budgeting, the Accounting Rate of Return (ARR) is a financial ratio used to evaluate the profitability of an investment. Unlike Net Present Value (NPV) or Internal Rate of Return (IRR), ARR uses accounting income rather than cash flows. To calculate ARR accurately, you must determine the Average Investment.

The Average Investment represents the book value of the asset over its useful life. Since an asset depreciates over time, the amount of capital "tied up" in the project decreases from the initial cost to the salvage value.

The Average Investment Formula

Average Investment = [(Initial Cost + Salvage Value) / 2] + Additional Working Capital

Step-by-Step Calculation Example

Suppose a company invests in a new piece of machinery with the following details:

  • Initial Cost: $100,000
  • Salvage Value: $20,000
  • Working Capital: $10,000 (funds required to operate the machine that will be recovered at the end)

Using the formula:

  1. Add Initial Cost and Salvage Value: $100,000 + $20,000 = $120,000
  2. Divide by 2: $120,000 / 2 = $60,000
  3. Add Working Capital: $60,000 + $10,000 = $70,000

The resulting $70,000 would be the denominator used to calculate the project's ARR.

Why Working Capital is Treated Differently

While the physical asset (the machine) depreciates, working capital (like inventory or cash) is generally considered to stay at a constant level throughout the project and is fully recovered at the end. Therefore, it is not divided by two in the standard average investment formula; it is added back in full because that amount of capital is committed for the entire duration of the project.

Key Considerations

  • Depreciation: The average investment calculation assumes straight-line depreciation is used to reach the salvage value.
  • ARR Accuracy: Some organizations use "Initial Investment" as the denominator instead of "Average Investment." Always check which method your accounting policy requires, as using the initial cost will result in a lower ARR percentage.
  • Net Income: Once you have the average investment, divide the Average Annual Accounting Profit by this number to get your ARR percentage.
function calculateAverageInvestment() { var initialCost = parseFloat(document.getElementById('initialCost').value); var salvageValue = parseFloat(document.getElementById('salvageValue').value); var workingCapital = parseFloat(document.getElementById('workingCapital').value); if (isNaN(initialCost)) { alert("Please enter the initial investment cost."); return; } if (isNaN(salvageValue)) { salvageValue = 0; } if (isNaN(workingCapital)) { workingCapital = 0; } // Formula: ((Initial + Salvage) / 2) + Working Capital var avgInv = ((initialCost + salvageValue) / 2) + workingCapital; var resultBox = document.getElementById('arrResultBox'); var resultDisplay = document.getElementById('arrResultValue'); var explanation = document.getElementById('arrExplanation'); resultDisplay.innerText = "$" + avgInv.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2}); explanation.innerText = "Calculated as ((" + initialCost.toLocaleString() + " + " + salvageValue.toLocaleString() + ") / 2) + " + workingCapital.toLocaleString(); resultBox.style.display = 'block'; } function resetARR() { document.getElementById('initialCost').value = "; document.getElementById('salvageValue').value = "; document.getElementById('workingCapital').value = '0'; document.getElementById('investmentDuration').value = "; document.getElementById('arrResultBox').style.display = 'none'; }

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