7.9b - Making Investment Decisions (ARR)

Question 1

Average rate of return definition

Answer 1

An appraisal method that calculates the annual return on an investment

Question 2

What can ARR be compared with?

Answer 2

• Interest rates paid on the money borrowed
• Return on other investments
• A benchmark return

Question 3

ARR formula

Answer 3

((Total net return / number of years) / initial cost) X 100

Question 4

What does it mean if the ARR is 15.6%?

Answer 4

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

Question 5

Appraisal definition

Answer 5

Looking at the strengths and weaknesses of something

Question 6

Advantages of ARR:

Answer 6

• Provides a percentage return which can be compared with a target return
• Looks at profitability of whole project
• Easy to calculate

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