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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Average Rate of Return
A2 Business StudiesSlide2
Aims and Objectives
To understand the investment appraisal technique: Average Rate of Return.
Analyse ARR results
Evaluate ARR methodSlide3
Explain what the payback method calculates.
Explain two benefits of the payback method.
Explain two drawbacks of payback method.Slide4
Average Rate of Return assesses the merits of an investment by calculating the average annual profit as a percentage of the initial investment.Slide5
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
Machine A =
(£750,000) + £142,500 + £192,500 + £252,500 + £252,500 + £292,500 = £382,500
Average Annual Profit =
£382,500/5 = £76,500Slide7
Divide the average annual profit by the initial investment and show as percentage.
ARR = (Average Annual Profit/Initial Investment) x 100Slide8
ARR = (£76,500/£750,000) x 100 = 10.2%
The ARR for machine A is 10.2 %Slide9
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.
Interest Rates and lending
Easy comparison with other forms of investment
Can compare with interest rate
Compared to current or target ROCE figureSlide13
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
Explain how to calculate ARR.
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