Accounting Rate of Return or Average Rate of Return (ARR)
- a financial ratio used in capital budgeting
- does not take into account the concept of time value of money
- calculates the return generated from net income of the proposed capital investment.
1. Investment without scrap value
Depreciation = Total Investment / Useful Life
ARR = [(Average Cash Flow - Depreciation) / Initial Investment] x 100%
2. Investment with a scrap value
Depreciation = (Total Investment - Scrap Value) / Useful Life
ARR = [(Average Cash Flow - Depreciation) / Initial Investment] x 100%
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