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Presentation ON Accounting Rate of Return (ARR) '

The document discusses the accounting rate of return (ARR) method for capital budgeting. ARR is calculated as the average annual profit after tax divided by the average total investment in the project, expressed as a percentage. The average investment is calculated as half the initial cost minus scrap value plus working capital and scrap value. An illustration calculates the ARR of 4% for a 5-year project by taking the average annual profit after tax of Rs. 2,200 and dividing it by the average total investment of Rs. 55,000. The calculated ARR is then compared to the company's required rate of return to determine if the project should be accepted or rejected.

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Yashika Bajaj
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361 views7 pages

Presentation ON Accounting Rate of Return (ARR) '

The document discusses the accounting rate of return (ARR) method for capital budgeting. ARR is calculated as the average annual profit after tax divided by the average total investment in the project, expressed as a percentage. The average investment is calculated as half the initial cost minus scrap value plus working capital and scrap value. An illustration calculates the ARR of 4% for a 5-year project by taking the average annual profit after tax of Rs. 2,200 and dividing it by the average total investment of Rs. 55,000. The calculated ARR is then compared to the company's required rate of return to determine if the project should be accepted or rejected.

Uploaded by

Yashika Bajaj
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd

Presentation ON Accounting Rate Of Return (ARR)

Accounting/Average Rate Of Return: The ARR is one of the Non-discounting techniques of Capital Budgeting along with Payback period technique. The ARR is based on the accounting concept of return on investment or rate of return. Definition:The ARR can be defined as the annualized Net Income earned on the average funds invested in a project. In other words, the annual returns of a project are expressed as a %age of the Net Investment in the project.

Computation Of ARR : Symbolically, ARR = Average Annual Profit (after tax) / Average Investment in the project * 100 Herein, Average Investment = 1/2(Initial costScrap) + (Scrap + Working Capital)
and; Average Profit after tax = Profit after tax/ No. of years

Illustration:- A company is investing Rs 1lacs in a project having an estimated life of 5 years after which it will realise a scrap value of Rs10000. The profit before taxes are as follows: Year Profit before taxes 1 8000 2 6000 3 2000 4 1000 5 5000 Assume the tax rate @50%

Solution:Herein, first we shall calculate the Profits after tax, which is @50% Year PAT 1 4000 2 3000 3 1000 4 500 5 2500 Therefore, Average Annual Profits = 11000/5=2200 Average Investment = 1/2(100000-10000) +10000=55000 Hence, ARR= 2200/55000 = .04%

Decision Rule:The ARR calculated is compared with the pre-specified rate of return. Obviously, if the ARR is more than this rate , then the project is likely to be accepted, otherwise not. For example, in the above case the ARR of the proposal came out to be .04%. In case the firm requires a rate of return of atleast .02%, then the proposal is acceptable. However, if the minimum rate of return is .05%, then the proposal shall be rejected.

Thank You

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