### Accounting Rate of Return (ARR) Examples

Definition: Accounting rate of return (ARR, also known as average rate of return) is used to estimate the rate of return for an investment project. The higher the ARR, the more attractive the project is. If the ARR is higher than the minimum standard average rate of return, then we will accept the project. However, this technique does not take into account of the time value of money.

Calculation and Formula:
ARR = Average profit / Average investment

Example 1:
An investment of \$600,000 is expected to give returns as follows: Year 1 (\$50,000), Year 2 (\$150,000), Year 3 (\$80,000), Year 4 (\$20,000).Calculate the average rate of return.
Solution:
Total returns over the four years = 50,000 + 150,000 + 80,000 + 20,000 = \$300,000
Average returns per annum = 300,000 / 4 = \$75,000
ARR = 75,000 / 600,000 = 12.5%

Example 2:
Western Ltd has an option of two projects: C and D, with the same initial capital investment of \$100,000. The profits for both projects are as follows:
Project C: Year 1 (\$10,000), Year 2 (\$5,000), Year 3 (\$15,000)
Project D: Year 1 (\$12,000), Year 2 (\$11,000), Year 3 (\$4,000)
The estimated resale value of both projects at the end of year 3 is \$22,000. Calculate the ARR for each project and advise the firm.
Solution:
For Project C:
Average profit = (10,000 + 5,000 + 15,000) / 3 = \$10,000
Average investment = (100,000 + 22,000) / 2 = \$61,000
Accounting rate of return = 10,000 / 61,000 = 16.39%

For Project D:
Average profit = (12,000 + 11,000 + 4,000) / 3 = \$9,000
Accounting rate of return = 9,000 / 61,000 = 14.75%

Since Project C has a higher ARR, it should be chosen.

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Abbey

Thank you so much. This is very
helpful I truly appreciate it. Thanks very much God bless you.

Sayantan

in the 1st eg avg invstment is not divided by 2 but in the later 1 it is divided by 2.....the reason is not understood.....explain please....
thanks

Anonymous

In the 1st eg, there is only one time capital investment so we divide the avg return by the original investment; while in the 2nd eg,there is a resale value \$22,000 so we need to take this formula: Avg investment = (Initial capital + disposal value) / 2

Anonymous

Thanks ,Thanks