This describe the ARR method and calculation of a capital investment project appraisal and list the advantages and disadvantages.

1. Accounting Rate of Return
(ARR)
By Shawn Bourne

2. What is the Accounting Rate of Return (ARR)
It is a method of capital investment appraisal which uses the accounting profits or earnings of
of an investment over the life of the investment and measure it against the the cost of the
investment to get the return on the investment.
It is calculated as follows:
ARR= Estimated average annual accounting profits x 100%
Estimated average investment
Average investment = Initial cost + disposal value
2

3. Example
A company has a target return of 20% on capital employed
Capital cost of asset 200,000.00
Estimated life 5 years
Estimated profit before depreciation:
Year 1 80,000.00
Year 2 85,000.00
Year 3 55,000.00
Year 4 65,000.00
Year 5 40,000.00
The asset will be depreciated using the straight method and it
has no scrap value.

4. Solution
Average profits (80,000+85,000+55,000+65,000+40,000)-
depreciation (200,000)
= 125,000.00 = 25,000.00
5 years 5
Average investment- 200,000 + 0 = 200,000.00 = 100,000.00
2 2
ARR = 25,000.00 x 100 = 25%
100,000.00
The project should be undertaken, since it exceeds
the target return of 20%.

5. Advantages and disadvantages of the ARR
Advantages:
1. It is quick and simple to calculate.
2. It looks at the entire life of the project.
3. It gives a clear picture of the profitability of a project.
Disadvantages:
1. It is based on accounting profits and not cash flows.
2. It ignores the time value of money