This accounting rate of return calculator estimates the (ARR/ROI) percentage of average profit earned from an investment (ROI) as compared with the average value of investment over the period. There is more information on how to calculate this indicator below the form.
How does this accounting rate of return calculator work?
This financial tool helps in evaluating the accounting profitability of investments by considering these variables:
Initial investment value;
Total working capital used during over the specified period;
Scrap value of the investment at the end;
Total accounting profit registered;
Years of investment.
The algorithm behind this accounting rate of return calculator is based on these formulas, while providing the results explained below:
Average profit = Total accounting profit registered / Years of investment
Average book value = (Initial investment + Working capital + Scrap value) / 2
Accounting rate of return (ARR/ROI) = Average profit / Average book value * 100
The interpretation of the ARR / AAR rate
Abbreviated as ARR and known as the Average Accounting Return (AAR) indicates the level of profitability of investments, thus the higher the percentage is the better. This figure is usually compared with a desired rate return on investment and in case exceeds it the investment plan may be approved by the investors in question.
Even though this indicator is a simple, easy and quick one to compute, it has few limitations when compared with other figures such as net present value (NPV) or internal rate of return (IRR). Amongst these limitations one is critical: ARR does not consider the cash flows evolution, while the moment in time the profits are generated is a critical aspect to analyze when evaluating an investment. This is because the moment revenues are generated are important as usually the return is further on reinvested, capitalized and may generate other revenue or profit. For instance an investment over 10 years that returns 80% of its profits within the first 5 years of its existence may prove to be a good opportunity, even though the ARR may show the opposite since it considers a time frame of 10 years.
Example of a calculation
Let's analyze an investment plan with these characteristics:
- initial investment = $100,000
- working capital used = $200,000
- scrap value = $50,000
- total accounting profit registered = $500,000
- period = 10 years.
■ Accounting rate of return (ARR/ROI): 28.57%
■ Average profit: $50,000.00
■ Average book value: $175,000.0018 Feb, 2015