3.3.2 Investment Appraisal-ARR (2/3)

Question 1

Average rate of return (ARR) is AKA

Answer 1

Accounting rate of return (ARR)

Question 2

Average rate of return

Answer 2

A method of investment appraisal that measure net return per annum as a percentage of the capital costs of the investment

Question 3

ARR calculation

Answer 3

Net return (Profit per annum)
——————————————– X 100
Capital cost

Question 4

Steps to calculate ARR

Answer 4

1) Calculate Total Net Cash flow ( By adding up all the years)
2) Find the Net Profit (By doing Total Net cash flow - capital cost )
3) Find Net Profit PA ( By doing Net profit/ number of years)

4) Net return PA
——————- X100
Capital cost

Question 5

Order to calculate

Answer 5

1) TNCF
2) NET PROFIT
3) NET PROFIT PA
4) ARR

Question 6

3 Advantages of ARR

Answer 6

1) Easy to calculate and simple to understand - doesn’t require complex maths
2) Determines a projects annual rate of return
3) Provides clear profitability

Question 7

Disadvantages of ARR

Answer 7

1) Ignores time value of money

2) - Ignores overall cash flow from the investment