Accounting rate of return

ARR

1. Accounting Rate of Return
(ARR)
Dr Indukoori S S N Raju

2. Accounting Rate of Return (ARR)
Itisthesimpletooltomakeacapitalbudgeting
decision.
Itconsidersthenetincomeandbookvalueof
investmentsforthelifeoftheprojectasstatedin
financialstatements.
Itdoesn’tconsidertimevalueofmoney.
Itisalsoknownas
Averagerateofreturn(ARR)
Accountingaveragerateofreturn(AARR)
Dr Indukoori S S N Raju 2

3. Types of ARR
ARRonAssetValue
CalculatesReturnonAssets(ROA)
ARRonCapitalInvested
CalculatesReturnonCapitalEmployed(ROCE)
Dr Indukoori S S N Raju 3

4. ARR on Asset Value
ProfitsafterexpensesisPATwhichincludesdepreciation,interestandTax.
IFPATisnotgiven,calculatePATfromEBDITbydeductingallitems.
Bookvalueisbasedondepreciationmethods.
Closingvalueisthescrapvalueornetdepreciatedvalue.
Dr Indukoori S S N Raju 4100*
sinvestment Average
return Average
ARR PeriodProject
PATs all ofSummation
Return Average  2
Value Closing Value Starting
Investment Average


It is return on assets ( ROA)

5. ARR –Problem 1
Dr Indukoori S S N Raju 5
AnewprojectisexpectedtogiveRs2.33crofcashflows
everyyearfor10yearswithaninvestmentofRs10Cr.
FinditsARR.

6. 0 1 5 10
Dr Indukoori S S N Raju 6
8 942 7
3
6
Rs
-10 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs
2. 33 Cr
Rs 0
Q.AnewprojectisexpectedtogiveRs2.33crofcash
flowseveryyearfor10yearswithaninvestmentofRs10
Cr.FinditsARR.
ARR on Asset Value -Problem 1
Solution46.6%100*
Cr 5 Rs
2.33 Rs
ARR 
Averagereturnscalculationnotrequiredastheyaresameforallyears.100*
sinvestment Average
return Average
ARR CrRs5
2
0 Cr 10 Rs
Investment Average 



7. ARR on Asset Value -Problem 2
Dr Indukoori S S N Raju 7
Anelectronicgadgetsmanufacturingcompanyiscontemplatingto
investRs100Crinitsexpansionprojecttomeetthedemandinthe
coming5years.ItsincrementalincomeforthisperiodisRs35Cr
everyyear.CalculateARRwithastraightlinedepreciation.

8. 0 1 5
Dr Indukoori S S N Raju 8
42 3
Rs 35Cr
Anelectronicgadgetsmanufacturingcompanyiscontemplatingto
investRs100Crinitsexpansionprojecttomeetthedemandinthe
coming5years.ItsincrementalincomeforthisperiodisRs35Cr
everyyear.CalculateARRwithastraightlinedepreciation.
ARR on Asset Value -Problem 2
Solution46.6%100*
Cr 50 Rs
Cr 35 Rs
ARR 
Averagereturnscalculationnotrequiredastheyaresameforallyears100*
sinvestment Average
return Average
ARR
Rs
-100 Cr
Rs 35Cr Rs 35Cr Rs 35Cr Rs 35CrCrRs50
2
0 Cr 100 Rs
Investment Average 



9. ARR on Asset Value -Problem 3
Dr Indukoori S S N Raju 9
Anautomobileancillaryunithasanewinvestmentopportunitywitha
capitalrequirementofRs50CroreswithanannualPBDITofRs10
Croreswith10%growtheveryyear.Intsinterestburdeandtaxrates
areRs50Lakhsand30%respectively.FindoutARRonthisproject
whichhasanannualassetdepreciationof10%and5yearsproject
life.

10. ARR on Asset Value -Problem 3
Solution
Dr Indukoori S S N Raju 10
Anautomobileancillaryunithasanewinvestmentopportunitywitha
capitalrequirementofRs50CroreswithanannualPBDITofRs10
Croreswith10%growtheveryyear.Intsinterestburdeandtaxrates
areRs50Lakhsand30%respectively.FindoutARRonthisproject
whichhasanannualassetdepreciationof10%and5yearsproject
life.
•FindoutannualgrossprofitorPBDITforeveryyearwithgrowth@
10%onpreviousyear.
•FindoutPATorNetIncomebydeductingDepreciation,Interest
andTaxPayment@30%onPBT
•Findoutdepreciationeveryyear@10%oninitialvalue
•Findoutclosingvalueorbookvalueofassetsafter5years

11. ARR on Asset Value -Problem 3
Solution
Dr Indukoori S S N Raju 11
543
Rs 10.00 CrRs 11.00 Cr Rs 12.10 Cr Rs 13.31 CrRs 14.64 Cr
PBDIT
PBIT Rs 5.00 Cr
PBT Rs 4.50 Cr
Rs 3.85 CrRs 4.62 CrRs 5.46 CrRs 6.39 CrPATRs 3.15 Cr
Rs 6.00 Cr Rs 7.1 Cr Rs 8.31 Cr Rs 9.64 Cr
(Depreciation)(Rs 5.00 Cr)(Rs 5.00 Cr) (Rs 5.00 Cr)(Rs 5.00 Cr)(Rs 5.00 Cr)
(Interest)(Rs 0.50 Cr) (Rs 0.50 Cr)(Rs 0.50 Cr)(Rs 0.50 Cr)(Rs 0.50 Cr)
(Tax) (Rs 1.35 Cr)
Rs 9.14 CrRs 7.81 CrRs 6.6 CrRs 5.50 Cr
(Rs 1.35 Cr)(Rs 2.34 Cr)(Rs 1.98 Cr)(Rs 1.65 Cr)
0 1 2
-Rs 50 CrRs 3.15 Cr Rs 3.85 Cr Rs 4.62 Cr Rs 5.46 CrRs 6.39 Cr

12. ARR on Asset Value -Problem 3
Solution
Dr Indukoori S S N Raju 12
•Deductions from PBDIT for 5 years to arrive at PAT
Year EBDIT
InRsCr
Depreciation
inRsCr
Interest
InRsCr
Tax
@ 30%
PAT
InRsCr
1 10.00 5 0.50 1.35 3.15
2 11.00 5 0.50 1.65 3.85
3 12.10 5 0.50 1.98 4.62
4 13.31 5 0.50 2.34 5.46
5 14.64 5 0.50 2.74 6.39
Total 25 23.47CrRs
CrRs
5.37
2
025Cr 50 Rs
Investment Average 

 CrRs694.4
5
Cr 23.47 Rs
Return Average  %5.12100*
37.5 Rs
Cr 4.69 Rs
ARR 

13. ARR on Capital Invested
CalculationissimilartoARRonAssetValue,butconsiderstotal
capitalinvestedinsteadofaveragebookvalueofassets.
Totalcapitalinvestedatthebeginningoftheprojectperiodis
considered.
Dr Indukoori S S N Raju 13100*
Invested Capital Total
PAT Average
ARR PeriodProject
Inflowscash all ofSummation
PAT Average 
Itisthereturnoncapitalemployed(ROCE)orinvested(ROCI)

14. Views on ARR
Advantages
Simplemeasure.
Easyaccesstoinformation.
Disadvantages
Canbeappliedforsituationstotakedecisionsatprima
faciesituationsbutnotforrealtimedecisions.
Thevalueisfromaccountingorfinancialstatementsbut
notmarketValue.
ARRcanbemanipulatedbychangingthedepreciation
methods.
Itismisleadingwhentwoprojectsofdifferentsizeare
comparedusingARR.
Dr Indukoori S S N Raju 14

15. Dr Indukoori S S N Raju 15
Thank You