7.9b Making Investment Decisions - ARR

Question 1

ARR meaning

Answer 1

Average rate of return

Question 2

What can ARR be compared with?

Answer 2

• The interest rates the firm pays on the money it borrows for investment
• The return on other comparable investments
• A benchmark return

Question 3

ARR formula

Answer 3

ARR (%) = ((total net return / no. of years) / initial cost) x 100

Question 4

If answer is 15.6% for example what does it suggest?

Answer 4

That every £1 worth of investment yields an average 15.6p return each year

Question 5

Appraisal definition

Answer 5

Looking at strengths and weaknesses of something

Question 6

Advantages of ARR:

Answer 6

• Provides a percentage return which can be compared with target return
• Looks at whole profitability of the project
• Focuses on profitability

Question 7

Disadvantages of ARR:

Answer 7

• Does not take into account cash flows - only profits
• Takes no account of the time value of money
• Treats profits arising late in the project in the same way as those which might arise early.