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It does not take into account the time value of money. To illustrate this point,
consider two investment proposals X and Y, each requiring an outlay of Rs
1,00,000. Both the proposals have an expected life of four years after which
their value would be nil. Relevant details of these proposals are given below
PROPOSALX
1,00,000 0 1,00,000
75,000 25,000 40,000 65,000
PROPOSALY
(1,00,000) 0 (1.00,000)
Both the proposals, with an accounting rate of return (measure A) of 50% look alike
from the accounting rate of return point of view, though project X, because it provides
benefits earlier, is much more desirable. While the payback period criterion gives no
weight to more distant benefits, the accounting rate of return criteria seems to give
them too much weight.
There are, as we have seen, numerous measures of accounting rate of return.
This can create controversy, confusion and more confusion, and problems in
interpretation.
The argument that the accounting rate of returm measure facilitates post-auditing
of capital expenditure is not very valid. The financial accounting system of a fim