20.1. Accounting (Simple) Rate of Return

Accounting rate of return (ARR) measures profitability from the conventional accounting standpoint by comparing the required investment (sometimes average investment) to future annual earnings.

Rule of thumb: Select the proposal with the highest ARR.

Example 1

NOTE

When average investment is used, rather than the initial investment, accounting rate of return is doubled.

Advantages of ARR

  • Easy to comprehend and calculate

  • Considers profitability

  • Numbers relate to financial statement presentation

  • Considers full useful life

Disadvantages of ARR

  • Ignores time value of money

  • Uses income data rather than cash flow data

NOTE

In an automated environment, the cost of the investment would include engineering, software development, and implementation.

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