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allocation of scarce capital. The average rate of return ("ARR") method of investment appraisal looks
at the total accounting return for a project to see if it meets the target return.
An example of an ARR calculation is shown below for a project with an investment of £2 million and
a total profit of £1,350,000 over the five years of the project.
The ARR for the project is 13.5% which seems a reasonable return. The project looks like it is worth
pursuing, assuming that the projected revenues and costs are realistic
A key question is - how does this return compare with the target return for investments by this
business?
Advantages of ARR
ARR provides a percentage return which can be compared with a target return
Disadvantages of ARR
Does not take into account cash flows – only profits (they may not be the same thing)
Treats profits arising late in the project in the same way as those which might arise early