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+--- Thread: Accounting Rate of Return (/thread-accounting-rate-of-return)
Accounting Rate of Return - Rob van Ginneken - 09-06-2005
I am looking for a norm/benchmark for ARR. For NPV (by definition) and IRR (by comparison to WACC, cost of capital) this speaks for itself, but for ARR I have not yet been able to find a decent figure.
What is a "good" ARR for an investment project?
Who can help me out?
- iahmad - 09-07-2005
ARR, accounting rate of return is calculated by Average Profit/Average Investment or Initial Investment. If a project runs for 3 years, estimates its profit and determine the avrdage profit by dividing the three years profits by number of yeras, This give you a average profit. Initial Investment is already knowm.
Benchmark!Rob the main reason of calculating the ARR is to detrmine the return which we expect from initial investment. Usually for capital investment decisions management usually compares this ARR with its required rate of return to detremine the acceptable project.
I hope this will help you.
- Moon - 09-16-2005
Well as regards the calculation ahmed you have posted are rite, the basic flaw or drawback in using the ARR is that it does not account for the cash flows and the time value of money which is a significant criticism.
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- Rob van Ginneken - 09-19-2005
Thanks guys, but you are both sort of missing my point. I am aware of the formula and the drawbacks of ARR, I just haven't seen any examples of what companies use for a benchmark (5, 10, 25%?) and the reasons for a particular number. So where IRR has a 'natural' benchmarkin WACC, what's ARR's?
- sumaaan - 09-19-2005
There are different norms for different industries and even more for different classes of projects. And in some industries, the norms might keep on changing due to different economic conditions and investor perceptions.
- CBPian - 09-20-2005
Assuming the funding of project does not change company's gearing; WACC can be used as a benchmark to compare with ARR as a decision point to accept or reject the project (albeit with caveats)
A more symmetric benchmark would be ROCE (return on capital employed)of the entity.
Remember, in the end, the most important criteria is that the project should increase shareholder's wealth.
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