Accounting Rate of Return Calculator

The Accounting Rate of Return (ARR) Calculator is a financial tool used to assess the profitability of investments. It's widely used in capital budgeting to measure the expected return on investment.

Historical Background

ARR has been a fundamental part of financial analysis and investment decision-making for decades. It's a straightforward method to evaluate the financial viability of capital investments.

Calculation Formula

The ARR is calculated using the following formula:

\[ \text{Accounting Rate of Return (ARR)} = \left( \frac{\text{Average Annual Profit}}{\text{Initial Investment}} \right) \times 100\% \]

Average Annual Profit is computed as:

\[ \text{Average Annual Profit} = \frac{\text{Registered Profit} + \text{Scrap Value} - \text{Initial Investment} - \text{Working Capital}}{\text{Years of Investment}} \]

Example Calculation

Suppose an investment has the following details:

• Registered Profit: $10,000
• Years of Investment: 5
• Initial Investment: $40,000
• Working Capital: $5,000
• Scrap Value: $2,000

Average Annual Profit:

\[ \text{Average Annual Profit} = \frac{\$10,000 + \$2,000 - \$40,000 - \$5,000}{5} = -\$6,600 \]

ARR:

\[ \text{ARR} = \left( \frac{-\$6,600}{\$40,000} \right) \times 100\% = -16.5\% \]

This negative ARR indicates that the investment is not profitable.

Importance and Usage Scenarios

ARR is important for:

1. Investment Decision-making: Helps investors and businesses evaluate the profitability of potential investments.
2. Comparing Projects: Useful in comparing the expected returns of different investment opportunities.
3. Budgeting: Assists in capital budgeting decisions.

Common FAQs

1. Is ARR the only metric to consider for investment decisions?

   • No. While useful, ARR should be used alongside other financial metrics like NPV and IRR for a comprehensive analysis.

2. Does ARR consider the time value of money?

   • No, ARR does not take into account the time value of money, which is a limitation of this method.

3. How does ARR differ from ROI?

   • ROI is a more general measure of the total return on investment, while ARR specifically measures the return from an accounting perspective.

4. Is a higher ARR always better?

   • Generally, a higher ARR indicates a more attractive investment, but other factors like risk and investment duration should also be considered.