Accounting Rate of Return (ARR) is a simple capital budgeting tool that considers net income and book value of investments as reported in financial statements, without regard to time value of money. There are two types: ARR on asset value, which calculates return on assets (ROA), and ARR on capital invested, which calculates return on capital employed (ROCE). ARR can be calculated by taking the average net income over the project life and dividing it by the average book value of assets or total capital invested. While simple to calculate, ARR does not consider market values or time value of money, and can be manipulated through depreciation methods.
Describes in detail the steps involved in the calculation of Internal Rate of Return. Useful to students of Under graduate, post graduate and professional course students pursuing course in finance
Describes in detail the steps involved in the calculation of Internal Rate of Return. Useful to students of Under graduate, post graduate and professional course students pursuing course in finance
Capital Budgeting is about how one should evaluate the financing options based on the superior financial performance through mathematical techniques. These techniques have been discussed in the presentation in detail.
Approaches to determine appropriate capital structure - EBIT-EPS Approch
anybody can join my google class (financial Mangement)
by entering class code : avkkvj5
This presentation is an overview of Capital Structure Theories.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
Weighted average cost is the average of the costs of specific sources of capital employed in a business, properly weighted by the proportion they hold in the firm’s capital structure.
Book Value :
Value shown in the balance sheet is called book value. Weightage to each source of finance is given on the basis of book value as recorded in the balance sheet.
Market Value :
Market value represent prices of prevailing in the stock market for securities. So current market price are applied in ascertaining the weightage.
time value of money
,
concept of time value of money
,
significance of time value of money
,
present value vs future value
,
solve for the present value
,
simple vs compound interest rate
,
nominal vs effective annual interest rates
,
future value of a lump sum
,
solve for the future value
,
present value of a lump sum
,
types of annuity
,
future value of an annuity
Net operating income (NOI) is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating expenses.
Watch out full video on youtube-
https://youtu.be/Suf9NAMW6Jg
Net Operating Income Approach
It proposes that -
Capital structure does not matter in determining the value of firm
It suggests that the value of firm remains same and is not affected by the change in debt composition of financing
Increase in debt composition results in increased risk perception by investors
Thus, firm appears to be more risky with more debt as capital which results in higher required rate of return by investors
The weighted average cost of capital and market value of firm remains same with increased cost of equity
Assumptions -
There are only two sources of financing – Debt & Equity
Value of equity is calculated by deducting the value of debt from total value of firm
Value of firm is EBIT / Overall cost of capital
WACC remains constant and with an increase in debt, the cost of equity increases
Dividend payout ratio is 1
No taxes & No retained earning
Thank you for Watching
Subscribe to DevTech Finance
Capital Budgeting is about how one should evaluate the financing options based on the superior financial performance through mathematical techniques. These techniques have been discussed in the presentation in detail.
Approaches to determine appropriate capital structure - EBIT-EPS Approch
anybody can join my google class (financial Mangement)
by entering class code : avkkvj5
This presentation is an overview of Capital Structure Theories.
Dr. Soheli Ghose ( Ph.D (University of Calcutta), M.Phil, M.Com, M.B.A., NET (JRF), B. Ed).
Assistant Professor, Department of Commerce,St. Xavier's College, Kolkata.
Guest Faculty, M.B.A. Finance, University of Calcutta, Kolkata
Weighted average cost is the average of the costs of specific sources of capital employed in a business, properly weighted by the proportion they hold in the firm’s capital structure.
Book Value :
Value shown in the balance sheet is called book value. Weightage to each source of finance is given on the basis of book value as recorded in the balance sheet.
Market Value :
Market value represent prices of prevailing in the stock market for securities. So current market price are applied in ascertaining the weightage.
time value of money
,
concept of time value of money
,
significance of time value of money
,
present value vs future value
,
solve for the present value
,
simple vs compound interest rate
,
nominal vs effective annual interest rates
,
future value of a lump sum
,
solve for the future value
,
present value of a lump sum
,
types of annuity
,
future value of an annuity
Net operating income (NOI) is a calculation used to analyze the profitability of income-generating real estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating expenses.
Watch out full video on youtube-
https://youtu.be/Suf9NAMW6Jg
Net Operating Income Approach
It proposes that -
Capital structure does not matter in determining the value of firm
It suggests that the value of firm remains same and is not affected by the change in debt composition of financing
Increase in debt composition results in increased risk perception by investors
Thus, firm appears to be more risky with more debt as capital which results in higher required rate of return by investors
The weighted average cost of capital and market value of firm remains same with increased cost of equity
Assumptions -
There are only two sources of financing – Debt & Equity
Value of equity is calculated by deducting the value of debt from total value of firm
Value of firm is EBIT / Overall cost of capital
WACC remains constant and with an increase in debt, the cost of equity increases
Dividend payout ratio is 1
No taxes & No retained earning
Thank you for Watching
Subscribe to DevTech Finance
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A Study on Capital Budgeting at Bharathi Cement Ltdijtsrd
The investment decision of a firm are generally known as the capital budgeting, or capital budgeting decisions may be defined as the firms decisions to invest its current funds most efficiently in the long term assets anticipation of an expected flow of benefits over a series of years .The long term assets are those that affect the firms operations beyond the one year period .The firm’s investment decisions would generally include expansion, acquisition, modernization and replacement of the long term assets. Sale of a division or business is also as an investment decision. Decisions like the change in the methods of sales distribution, or an advertisements campaign or a research and development programmes have long term implications for the firms expenditure and benefits, and therefore they should also be evaluated as investment decisions. It is important to note that investment is the long assets invariably requires large funds to be tied up in the current assets such as inventories and receivables. As such, investment in fixed and current assets is one single activity. A D Mamatha | Dr. P. Basaiah "A Study on Capital Budgeting at Bharathi Cement Ltd" Published in International Journal of Trend in Scientific Research and Development (ijtsrd), ISSN: 2456-6470, Volume-4 | Issue-6 , October 2020, URL: https://www.ijtsrd.com/papers/ijtsrd33161.pdf Paper Url: https://www.ijtsrd.com/management/other/33161/a-study-on-capital-budgeting-at-bharathi-cement-ltd/a-d-mamatha
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Prepare a presentation or a paper using research, basic comparative analysis, data organization and application of economic information. You will make an informed assessment of an economic climate outside of the United States to accomplish an entertainment industry objective.
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2. Accounting Rate of Return (ARR)
It is the simple tool to make a capital budgeting
decision.
It considers the net income and book value of
investments for the life of the project as stated in
financial statements.
It doesn’t consider time value of money.
It is also known as
Average rate of return (ARR)
Accounting average rate of return (AARR)
Dr Indukoori S S N Raju 2
3. Types of ARR
ARR on Asset Value
Calculates Return on Assets (ROA)
ARR on Capital Invested
Calculates Return on Capital Employed (ROCE)
Dr Indukoori S S N Raju 3
4. ARR on Asset Value
Profits after expenses is PAT which includes depreciation, interest and Tax.
IF PAT is not given, calculate PAT from EBDIT by deducting all items.
Book value is based on depreciation methods.
Closing value is the scrap value or net depreciated value.
Dr Indukoori S S N Raju 4
100
*
s
investment
Average
return
Average
ARR
Period
Project
PATs
all
of
Summation
Return
Average
2
Value
Closing
Value
Starting
Investment
Average
It is return on assets ( ROA)
5. ARR – Problem 1
Dr Indukoori S S N Raju 5
A new project is expected to give Rs 2.33 cr of cash flows
every year for 10 years with an investment of Rs 10 Cr.
Find its ARR.
6. 0 1 5 10
Dr Indukoori S S N Raju 6
8 9
4
2 7
3 6
Rs
-10 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs 0
Q. A new project is expected to give Rs 2.33 cr of cash
flows every year for 10 years with an investment of Rs 10
Cr. Find its ARR.
ARR on Asset Value - Problem 1
Solution
46.6%
100
*
Cr
5
Rs
2.33
Rs
ARR
Average returns calculation not required as they are same for all years.
100
*
s
investment
Average
return
Average
ARR
Cr
Rs5
2
0
Cr
10
Rs
Investment
Average
7. ARR on Asset Value - Problem 2
Dr Indukoori S S N Raju 7
An electronic gadgets manufacturing company is contemplating to
invest Rs 100 Cr in its expansion project to meet the demand in the
coming 5 years. Its incremental income for this period is Rs 35 Cr
every year. Calculate ARR with a straight line depreciation.
8. 0 1 5
Dr Indukoori S S N Raju 8
4
2 3
Rs 35Cr
An electronic gadgets manufacturing company is contemplating to
invest Rs 100 Cr in its expansion project to meet the demand in the
coming 5 years. Its incremental income for this period is Rs 35 Cr
every year. Calculate ARR with a straight line depreciation.
ARR on Asset Value - Problem 2
Solution
46.6%
100
*
Cr
50
Rs
Cr
35
Rs
ARR
Average returns calculation not required as they are same for all years
100
*
s
investment
Average
return
Average
ARR
Rs
-100 Cr
Rs 35Cr Rs 35Cr Rs 35Cr Rs 35Cr
Cr
Rs50
2
0
Cr
100
Rs
Investment
Average
9. ARR on Asset Value - Problem 3
Dr Indukoori S S N Raju 9
An automobile ancillary unit has a new investment opportunity with a
capital requirement of Rs 50 Crores with an annual PBDIT of Rs 10
Crores with 10% growth every year. Ints interest burde and tax rates
are Rs 50 Lakhs and 30% respectively. Find out ARR on this project
which has an annual asset depreciation of 10% and 5 years project
life.
10. ARR on Asset Value - Problem 3
Solution
Dr Indukoori S S N Raju 10
An automobile ancillary unit has a new investment opportunity with a
capital requirement of Rs 50 Crores with an annual PBDIT of Rs 10
Crores with 10% growth every year. Ints interest burde and tax rates
are Rs 50 Lakhs and 30% respectively. Find out ARR on this project
which has an annual asset depreciation of 10% and 5 years project
life.
• Find out annual gross profit or PBDIT for every year with growth @
10% on previous year.
• Find out PAT or Net Income by deducting Depreciation, Interest
and Tax Payment @ 30% on PBT
• Find out depreciation every year @10% on initial value
• Find out closing value or book value of assets after 5 years
12. ARR on Asset Value - Problem 3
Solution
Dr Indukoori S S N Raju 12
• Deductions from PBDIT for 5 years to arrive at PAT
Year EBDIT
In Rs Cr
Depreciation
in Rs Cr
Interest
In Rs Cr
Tax
@ 30%
PAT
In Rs Cr
1 10.00 5 0.50 1.35 3.15
2 11.00 5 0.50 1.65 3.85
3 12.10 5 0.50 1.98 4.62
4 13.31 5 0.50 2.34 5.46
5 14.64 5 0.50 2.74 6.39
Total 25 23.47
Cr
Rs
Cr
Rs
5
.
37
2
0
25
Cr
50
Rs
Investment
Average
Cr
Rs 694
.
4
5
Cr
23.47
Rs
Return
Average
%
5
.
12
100
*
37.5
Rs
Cr
4.69
Rs
ARR
13. ARR on Capital Invested
Calculation is similar to ARR on Asset Value, but considers total
capital invested instead of average book value of assets.
Total capital invested at the beginning of the project period is
considered.
Dr Indukoori S S N Raju 13
100
*
Invested
Capital
Total
PAT
Average
ARR
Period
Project
Inflows
cash
all
of
Summation
PAT
Average
It is the return on capital employed (ROCE) or invested (ROCI)
14. Views on ARR
Advantages
Simple measure.
Easy access to information.
Disadvantages
Can be applied for situations to take decisions at prima
facie situations but not for real time decisions.
The value is from accounting or financial statements but
not market Value.
ARR can be manipulated by changing the depreciation
methods.
It is misleading when two projects of different size are
compared using ARR.
Dr Indukoori S S N Raju 14