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 ID: 169498
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Slide1
Average Rate of Return
A2 Business StudiesSlide2
Aims and Objectives
Aim:
To understand the investment appraisal technique: Average Rate of Return.
Objectives:
Define ARR
Calculate ARR
Analyse ARR results
Evaluate ARR methodSlide3
Starter
Explain what the payback method calculates.
Explain two benefits of the payback method.
Explain two drawbacks of payback method.Slide4
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.Slide5
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 YearsSlide6
Step 1
Machine A =
(£750,000) + £142,500 + £192,500 + £252,500 + £252,500 + £292,500 = £382,500
Average Annual Profit =
£382,500/5 = £76,500Slide7
Step 2
Divide the average annual profit by the initial investment and show as percentage.
ARR = (Average Annual Profit/Initial Investment) x 100Slide8
Step 2
ARR = (£76,500/£750,000) x 100 = 10.2%
The ARR for machine A is 10.2 %Slide9
Machine B
Calculate the ARR for machine B.
Show all calculations and formulas in your working out.
Make everything obvious to the examiner!Slide10
Analysis and Evaluation of ARR
Higher the ARR the more potentially profitable the investment.
Analyse machine A’s and machine B’s ARR.Slide11
Evaluation: Benefits & Drawbacks
Discuss the benefits and drawbacks of ARR method.
Consider:
Interest Rates and lending
ROCE
Cash Inflows
ComparisonsSlide12
Evaluation: Benefits
Easy comparison with other forms of investment
Can compare with interest rate
Compared to current or target ROCE figureSlide13
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 survivalSlide14
Plenary
Define ARR
Explain how to calculate ARR.