Accounting rate of return （ARR）
>> The ARR measure also called Return on capital employed（ROCE） or Return on investment （ROI）.
>> It is a measure of the impact of an investment on accounting profit.
>> It may be calculated many ways and is based upon profit （which already allows scope for manipulation）.
The most common formula for examinations is:
ARR (ROCE)=(estimated average or total profits)/Estimated average or initial investment)*100%
Average annual profit
Average annual profit = Total operating profit / No. of years
* Total operating profit = Sales – all operating cashflow - depreciation
Investment
Average investment=(Capota; cost+disposal value) / 2
Initial capital cost = Initial investment
Decision rule:
>> ARR VS company’s target ROCE
If the ARR is greater we will accept the investment.
dvantages:
1. It is a quick and simple calculation
2. Can be calculated from available accounting data.
3. It gives a relative measure which it is easy to compare to investment options.
4. It looks at the entire project life.
Disadvantages:
1. It is based on accounting profits and not cash flow. Accounting profits are subject to a number of different accounting treatments.
2. It does not consider the time value of money.
3. It takes no account of the length of the project.
4. It is a relative measure rather than an absolute measure of return, and hence takes no account of the size of investment.
Back：Overtrading
Next：Discounted cash flow （DCF） techniques
>> It is a measure of the impact of an investment on accounting profit.
>> It may be calculated many ways and is based upon profit （which already allows scope for manipulation）.
The most common formula for examinations is:
ARR (ROCE)=(estimated average or total profits)/Estimated average or initial investment)*100%
Average annual profit
Average annual profit = Total operating profit / No. of years
* Total operating profit = Sales – all operating cashflow - depreciation
Investment
Average investment=(Capota; cost+disposal value) / 2
Initial capital cost = Initial investment
Decision rule:
>> ARR VS company’s target ROCE
If the ARR is greater we will accept the investment.
dvantages:
1. It is a quick and simple calculation
2. Can be calculated from available accounting data.
3. It gives a relative measure which it is easy to compare to investment options.
4. It looks at the entire project life.
Disadvantages:
1. It is based on accounting profits and not cash flow. Accounting profits are subject to a number of different accounting treatments.
2. It does not consider the time value of money.
3. It takes no account of the length of the project.
4. It is a relative measure rather than an absolute measure of return, and hence takes no account of the size of investment.
Back：Overtrading
Next：Discounted cash flow （DCF） techniques
