- Trending Categories
- Data Structure
- Networking
- RDBMS
- Operating System
- Java
- iOS
- HTML
- CSS
- Android
- Python
- C Programming
- C++
- C#
- MongoDB
- MySQL
- Javascript
- PHP

- Selected Reading
- UPSC IAS Exams Notes
- Developer's Best Practices
- Questions and Answers
- Effective Resume Writing
- HR Interview Questions
- Computer Glossary
- Who is Who

**ARR** stands for Accounting Rate of Return. It is one of the Non- Discounted cash flow techniques used for calculating capital budgeting.

ARR is the average net income of an asset (anticipated) divided by its average capital cost. It is generally expressed as an annual percentage. ARR does not take in account the time value of money or cash flows, which are integral part of maintaining a business.

ARR is useful for a quick calculation of an investments probability.

ARR is mainly used for comparison between multiple projects to determine the ARR for each.

ARR is mainly used for comparison between multiple projects to determine the ARR for each.

$$ARR=\frac{Average\:net\:profit}{average\:investment}$$

Average profit = total profit over investment period/ number of years.

Average investment = (book value at first year + book value at end of useful life)/2.

Company X is looking to invest in some new machinery to replace its current one.

**New machinery details** −

Cost : Rs.4, 20,000/- would increase annual revenue by Rs.2, 00,000/- Annual expenses : Rs.50, 000/- Life of new machinery : 12 years Salvage value : 0

**Solution**

**Step 1 ** − Calculate depreciation expenses per year.

Depreciation expense per year =$\frac{cost\:of\:machinery}{life\:of\:machinery} \Rightarrow\frac{420000}{12}\Rightarrow$Rs. 35000/-

**Step 2** − Calculate average annual profit.

Average annual profit = annual revenue of new machinery – (annual expenses + step 1)

= 200000 – (50000+35000) => Rs. 1,15,000/-

**Step 3** Calculate ARR by using above formula.

$$ARR=\frac{step 2}{total\:cost} \Rightarrow\frac{115000}{420000}\Rightarrow27.4\%$$

That means for every Rs.100/- invested, investment will return a profit of about Rs.27/-

Company Y is considering investing in a project that requires an initial investment of Rs. 1, 00,000/- for some machinery. There will be net flows of Rs. 20,000/- for first two years and Rs. 10,000/- for year 3 & 4, and Rs. 30,000/- for year 5. Machine has a salvage value of Rs. 25,000

**Solution**

**Step 1** − Calculate average annual profit.

Inflow | Rs. | |
---|---|---|

YEAR 1 & 2 | 20000*2 | 40000 |

YEAR 3 &4 | 10000*2 | 20000 |

YEAR 5 | 15000 | 30000 |

(-) Deprecation | 100000-25000 (salvage value) | (75000) |

Total profit of project | 15000 |

$$ARR=\frac{total\:profit\:of\:project}{life\:of\:project} \Rightarrow\frac{15000}{5}\Rightarrow3000/-$$

**Step 2** − Calculate average investment.

$$Average investment =\frac{100000+25000}{2} \Rightarrow Rs.62500/-$$

**Step 3** − Calculate ARR.

$$ARR=\frac{step 1}{step 2} \Rightarrow\frac{3000}{62500}=4.8\%$$

- Related Questions & Answers
- What is Profitability index in discounted cash flow technique in capital budgeting?
- Define NPV in discounted cash flow technique in capital budgeting.
- Explain about payback period in non-discounted cash flow technique in capital budgeting.
- What is Capital Cash Flow method?
- What are Operating cash flow in accounting?
- What is Capital Budgeting?
- What are Investing activities in cash flow in accounting?
- What are cash flow from Financial activities in accounting?
- Explain discounted cash flow analysis in merger and acquisitions
- What is capital budgeting in finance?
- What is Risk-adjusted Discounted Rate Method?
- What is Payback Period in Capital Budgeting?
- What is Simulation Analysis in Capital Budgeting?
- What is Free Cash Flow?
- How to calculate Accounting Rate of Return?

Advertisements