Accounting Rate of Return (ARR) is a simple capital budgeting tool that considers net income and book value of investments as reported in financial statements, without regard to time value of money. There are two types: ARR on asset value, which calculates return on assets (ROA), and ARR on capital invested, which calculates return on capital employed (ROCE). ARR can be calculated by taking the average net income over the project life and dividing it by the average book value of assets or total capital invested. While simple to calculate, ARR does not consider market values or time value of money, and can be manipulated through depreciation methods.

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

2. Accounting Rate of Return (ARR)
 It is the simple tool to make a capital budgeting
decision.
 It considers the net income and book value of
investments for the life of the project as stated in
financial statements.
 It doesn’t consider time value of money.
 It is also known as
 Average rate of return (ARR)
 Accounting average rate of return (AARR)
Dr Indukoori S S N Raju 2

3. Types of ARR
 ARR on Asset Value
Calculates Return on Assets (ROA)
 ARR on Capital Invested
Calculates Return on Capital Employed (ROCE)
Dr Indukoori S S N Raju 3

4. ARR on Asset Value
 Profits after expenses is PAT which includes depreciation, interest and Tax.
 IF PAT is not given, calculate PAT from EBDIT by deducting all items.
 Book value is based on depreciation methods.
 Closing value is the scrap value or net depreciated value.
Dr Indukoori S S N Raju 4
100
*
s
investment
Average
return
Average
ARR 
Period
Project
PATs
all
of
Summation
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
A new project is expected to give Rs 2.33 cr of cash flows
every year for 10 years with an investment of Rs 10 Cr.
Find its ARR.

6. 0 1 5 10
Dr Indukoori S S N Raju 6
8 9
4
2 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. A new project is expected to give Rs 2.33 cr of cash
flows every year for 10 years with an investment of Rs 10
Cr. Find its ARR.
ARR on Asset Value - Problem 1
Solution
46.6%
100
*
Cr
5
Rs
2.33
Rs
ARR 

 Average returns calculation not required as they are same for all years.
100
*
s
investment
Average
return
Average
ARR 
Cr
Rs5
2
0
Cr
10
Rs
Investment
Average 



7. ARR on Asset Value - Problem 2
Dr Indukoori S S N Raju 7
An electronic gadgets manufacturing company is contemplating to
invest Rs 100 Cr in its expansion project to meet the demand in the
coming 5 years. Its incremental income for this period is Rs 35 Cr
every year. Calculate ARR with a straight line depreciation.

8. 0 1 5
Dr Indukoori S S N Raju 8
4
2 3
Rs 35Cr
An electronic gadgets manufacturing company is contemplating to
invest Rs 100 Cr in its expansion project to meet the demand in the
coming 5 years. Its incremental income for this period is Rs 35 Cr
every year. Calculate ARR with a straight line depreciation.
ARR on Asset Value - Problem 2
Solution
46.6%
100
*
Cr
50
Rs
Cr
35
Rs
ARR 

Average returns calculation not required as they are same for all years
100
*
s
investment
Average
return
Average
ARR 
Rs
-100 Cr
Rs 35Cr Rs 35Cr Rs 35Cr Rs 35Cr
Cr
Rs50
2
0
Cr
100
Rs
Investment
Average 



9. ARR on Asset Value - Problem 3
Dr Indukoori S S N Raju 9
An automobile ancillary unit has a new investment opportunity with a
capital requirement of Rs 50 Crores with an annual PBDIT of Rs 10
Crores with 10% growth every year. Ints interest burde and tax rates
are Rs 50 Lakhs and 30% respectively. Find out ARR on this project
which has an annual asset depreciation of 10% and 5 years project
life.

10. ARR on Asset Value - Problem 3
Solution
Dr Indukoori S S N Raju 10
An automobile ancillary unit has a new investment opportunity with a
capital requirement of Rs 50 Crores with an annual PBDIT of Rs 10
Crores with 10% growth every year. Ints interest burde and tax rates
are Rs 50 Lakhs and 30% respectively. Find out ARR on this project
which has an annual asset depreciation of 10% and 5 years project
life.
• Find out annual gross profit or PBDIT for every year with growth @
10% on previous year.
• Find out PAT or Net Income by deducting Depreciation, Interest
and Tax Payment @ 30% on PBT
• Find out depreciation every year @10% on initial value
• Find out closing value or book value of assets after 5 years

11. ARR on Asset Value - Problem 3
Solution
Dr Indukoori S S N Raju 11
5
4
3
Rs 10.00 Cr Rs 11.00 Cr Rs 12.10 Cr Rs 13.31 Cr Rs 14.64 Cr
PBDIT
PBIT Rs 5.00 Cr
PBT Rs 4.50 Cr
Rs 3.85 Cr Rs 4.62 Cr Rs 5.46 Cr Rs 6.39 Cr
PAT Rs 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 Cr
Rs 7.81 Cr
Rs 6.6 Cr
Rs 5.50 Cr
(Rs 1.35 Cr)
(Rs 2.34 Cr)
(Rs 1.98 Cr)
(Rs 1.65 Cr)
0 1 2
- Rs 50 Cr Rs 3.15 Cr Rs 3.85 Cr Rs 4.62 Cr Rs 5.46 Cr Rs 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
In Rs Cr
Depreciation
in Rs Cr
Interest
In Rs Cr
Tax
@ 30%
PAT
In Rs Cr
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 23.47
Cr
Rs
Cr
Rs
5
.
37
2
0
25
Cr
50
Rs
Investment
Average 


Cr
Rs 694
.
4
5
Cr
23.47
Rs
Return
Average 

%
5
.
12
100
*
37.5
Rs
Cr
4.69
Rs
ARR 


13. ARR on Capital Invested
 Calculation is similar to ARR on Asset Value, but considers total
capital invested instead of average book value of assets.
 Total capital invested at the beginning of the project period is
considered.
Dr Indukoori S S N Raju 13
100
*
Invested
Capital
Total
PAT
Average
ARR 
Period
Project
Inflows
cash
all
of
Summation
PAT
Average 
It is the return on capital employed (ROCE) or invested (ROCI)

14. Views on ARR
Advantages
 Simple measure.
 Easy access to information.
Disadvantages
 Can be applied for situations to take decisions at prima
facie situations but not for real time decisions.
 The value is from accounting or financial statements but
not market Value.
 ARR can be manipulated by changing the depreciation
methods.
 It is misleading when two projects of different size are
compared using ARR.
Dr Indukoori S S N Raju 14

15. Dr Indukoori S S N Raju 15
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