Accounting Rate of Return — Microsoft Excel
In this article, we will delve into the intricacies of accounting rate of return in finance using excel. As we understand a term rate of return, which is basically another metric to identify weather a investment is good for business, we can easily calculate the profit of investment that is expected to generate.
Accounting Rate of Return
The accounting rate of return method is another metric to decide whether an investment is good. This method calculates the average accounting profit that an
investment is expected to generate and presents it as a percentage of the average investment in the project, as measured using accounting terms. To decide whether the return is acceptable, we must compare it with the minimum required return by the business. If the firm has a target ARR less than the percentage
achieved, then the investment is acceptable, otherwise it is not.
Formula:
ARR: Average Annual Profit/Average Investment.
Where Average Annual Profit: Total Profits/Number of Years.
Average Investment:
(Initial Investment + Salvage Value)/2.
Example: ABCD Co Ltd. is considering a project with a required investment of
₹6,00,000/-. The details are as follows,
Expected Useful life: 6 Years, SLM method.
Salvage Value: 1,50,000/-
The cost of capital:
28%
Net Profit
Year 1: 60,000/-
Year 2: 90,000/-
Year 3: 1,10,000/-
Year 4: 1,50,000/-
Year 5: 1,10,000/-
Year 6: 90,000/-
As we can see in the above figure, ARR (27.11%) is less than the cost of capital (28%), so it is not acceptable.
Conclusion
Finally, we will understanding the basic methods and concepts of accounting rate of return in finance and along with this approach we will also learn how to identify and estimate our new expected investment for another project for our company or business progression towards successful journey.
