File Name: accounting rate of return questions and answers .zip
If you have already studied other capital budgeting methods net present value method , internal rate of return method and payback method , you may have noticed that all these methods focus on cash flows. But accounting rate of return ARR method uses expected net operating income to be generated by the investment proposal rather than focusing on cash flows to evaluate an investment proposal. Otherwise, it is rejected. The accounting rate of return is computed using the following formula:. In the above formula, the incremental net operating income is equal to incremental revenues to be generated by the asset less incremental operating expenses. The incremental operating expenses also include depreciation of the asset.
Accounting Rate of Return ARR is one of the best ways to calculate the potential profitability of an investment, making it an effective means of determining which capital asset or long-term project to invest in. But how do you do an ARR calculation? Find out everything you need to know about the Accounting Rate of Return formula and how to calculate ARR, right here. Accounting Rate of Return ARR is the percentage rate of return that is expected from an investment or asset compared to the initial cost of investment. Typically, ARR is used to make capital budgeting decisions.
Investments may be accepted if the ARR exceeds the target return. Whereas average profit is fairly simple to calculate, there are several ways to calculate the average book value of investment. One of the simplest and quickest ways of calculating the average net book value of investment assets is by finding a simple average of:. In case where subsequent investments are to be made after the initial investment, the above formula would not account for the additional investment. Instead, the average book value shall be found by adding the net book value N. You may see the example below for an illustration of how to apply the above formulas. Note that the value of investment assets at the end of 5th year i.
Solution: (1): Computation of accounting rate of return: = $60,* / $,**. = %. *Incremental net operating income: Incremental revenues – Incremental.
By Madhuri Thakur. The initial investment required to be made for this new project is , Based on this information, you are required to calculate the accounting rate of return. Here we are given annual revenue, which is 50, and expenses as 20, Hence the net profit will be 30, for the next ten years, and that shall be the average net profit for the project.
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Investment decisions involve comparison of benefits of a project with its cash outlay. So these decisions are of considerable significance. It is the simplest and most widely used method for appraising capital expenditure decisions. Payback Period measures the rapidity with which the project cost will be recovered. It is usually expressed in terms of years. There are two methods for computing the payback period.
Accounting rate of return also known as simple rate of return is the ratio of estimated accounting profit of a project to the average investment made in the project. ARR is used in investment appraisal. Average accounting profit is the arithmetic mean of accounting income expected to be earned during each year of the project's life time. Average investment may be calculated as the sum of the beginning and ending book value of the project divided by 2. Another variation of ARR formula uses initial investment instead of average investment. Accept the project only if its ARR is equal to or greater than the required accounting rate of return. In case of mutually exclusive projects, accept the one with highest ARR.
b) Which of the two options should be chosen based on the ARR calculation? Page 4. Answers. Question 1. %.
FFM study guide reference E3b requires candidates to not only be able to calculate the accounting rate of return, but also to be able to discuss the usefulness of the accounting rate of return as a method of investment appraisal. Recent FFM exam sittings have shown that candidates are struggling with the concept of the accounting rate of return and this article aims to help candidates with this topic. Candidates should note that accounting rate of return can not only be examined within the FFM syllabus, but also the F9 syllabus.
The return on capital or invested capital in a business attempts to measure the return earned on capital invested in an investment. Return can be referred to as the measure of t otal gain or loss from an investment over a given time peri od with respect to both … Note to students: In problems involving the internal rate of return calculation, a financial calculator has been used. PDF Capital budgeting is one of the most important areas of financial management.
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