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Average Rate of Return A2 Business Studies
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Average Rate of Return

Dec 31, 2015

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Average Rate of Return. A2 Business Studies. Aims and Objectives. Aim: To understand the investment appraisal technique: Average Rate of Return. Objectives: Define ARR Calculate ARR Analyse ARR results Evaluate ARR method. Starter. Explain what the payback method calculates. - PowerPoint PPT Presentation
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Page 1: Average Rate of Return

Average Rate of ReturnA2 Business Studies

Page 2: Average Rate of Return

Aims and Objectives

Aim:• To understand the investment appraisal technique:

Average Rate of Return.

Objectives:• Define ARR• Calculate ARR• Analyse ARR results• Evaluate ARR method

Page 3: Average Rate of Return

Starter

Explain what the payback method calculates.

Explain two benefits of the payback method.

Explain two drawbacks of payback method.

Page 4: Average Rate of Return

ARR Definition

Average Rate of Return assesses the merits of an

investment by calculating the average annual profit as a

percentage of the initial investment.

Page 5: Average Rate of Return

Step 1

Calculate the average annual profit by adding up all net

cash flows divided by the number of years.

Average annual profit

= Total net cash flow / Number of Years

Page 6: Average Rate of Return

Step 1

Machine A =

(£750,000) + £142,500 + £192,500 + £252,500 +

£252,500 + £292,500 = £382,500

Average Annual Profit =

£382,500/5 = £76,500

Page 7: Average Rate of Return

Step 2

Divide the average annual profit by the initial

investment and show as percentage.

ARR = (Average Annual Profit/Initial Investment) x 100

Page 8: Average Rate of Return

Step 2

ARR = (£76,500/£750,000) x 100 = 10.2%

The ARR for machine A is 10.2 %

Page 9: Average Rate of Return

Machine B

Calculate the ARR for machine B.

Show all calculations and formulas in your working

out.

Make everything obvious to the examiner!

Page 10: Average Rate of Return

Analysis and Evaluation of ARR

Higher the ARR the more potentially profitable the

investment.

Analyse machine A’s and machine B’s ARR.

Page 11: Average Rate of Return

Evaluation: Benefits & Drawbacks

• Discuss the benefits and drawbacks of ARR method.

• Consider:

Interest Rates and lending

ROCE

Cash Inflows

Comparisons

Page 12: Average Rate of Return

Evaluation: Benefits

• Easy comparison with other forms of investment

• Can compare with interest rate

• Compared to current or target ROCE figure

Page 13: Average Rate of Return

Evaluation: Drawbacks

• Does not take into account specific timings of cash inflows.

• An investment may appear profitable, but if it takes four

years before a positive net cash flow is achieved this

might threaten the firm’s short term survival

Page 14: Average Rate of Return

Plenary

• Define ARR

• Explain how to calculate ARR.