Answer
See explanation
Work Step by Step
The annual rate of return (ARR) technique measures the accounting return on an investment rather than its cash flows.
Formula for ARR
$\text{ARR}
=\frac{\text{
Average Annual Accounting Profit}}{\text{
Initial Investment}}\times 100$
1) Average Annual Accounting Profit
- Typically calculated as (Total Accounting Profit over project life) ÷ Number of years.
- Uses accounting profits, not cash flows.
2) Initial Investment
- The total amount invested at the beginning of the project.
3) Decision Rule
- If ARR ≥ required rate of return, accept the project.
- If ARR < required rate of return, reject the project.
So the ARR technique focuses on accounting profit relative to investment, unlike NPV or IRR, which consider cash flows and time value of money.
