Topic №11: Evaluation of financial and economic efficiency of investment projects

Accounting rate of return

Also known as the Average rate of return, or ARR is a financial ratio used in capital budgeting. The ratio does not take into account the concept of time value of money. ARR calculates the return, generated from net income of the proposed capital investment. The ARR is a percentage return. Say, if ARR = 7%, then it means that the project is expected to earn seven cents out of each dollar invested (yearly). If the ARR is equal to or greater than the required rate of return, the project is acceptable. If it is less than the desired rate, it should be rejected. When comparing investments, the higher the ARR, the more attractive the investment. Over one-half of large firms calculate ARR when appraising projects.

ARR =	EBIT(1-IT)
	(Cb - Ce)/2

The indicator of Accounting Rate of Return
is the return according to the contents
to a pay-back period of capital investments.
Basic formula:

• Where:
• ARR-Accounting rate of return;
• EBIT- Earning before interest and tax;
• IT-Income tax;
• Cb- the value of capital at the beginning of 1st year;
• Ce- the value of capital at the end of use.

Example 3: Company G is planning to buy a new technological line which costs 1000 million soums with the term of operation of 10 years. By calculations, it will bring the additional earning (income) before payment percents and taxes 200 million soums. After operation term sale of the line isn't planned. Rate of the taxation is 24%. Profitability of investments before purchase of technology was 20%.

• Example 3: Company G is planning to buy a new technological line which costs 1000 million soums with the term of operation of 10 years. By calculations, it will bring the additional earning (income) before payment percents and taxes 200 million soums. After operation term sale of the line isn't planned. Rate of the taxation is 24%. Profitability of investments before purchase of technology was 20%.
• Solution: