# How to calculate the accounting rate of return

Knowing how to calculate accounting return on investment (ARR) is important in capital planning as it is used to determine the adequacy of a particular investment. If the response for ARR exceeds a certain rate accepted by the company, the project will be selected.

## Formula for calculating the discount rate (ARR)

ARR can be calculated using the following formula:

The average book profit is the mean value of the book profit that is expected to be achieved within the project duration. Instead of the initial investment, there are cases where the average investment is used.

The decision to accept or reject a project is based on the value generated in RR. The project is accepted if the ARR value is equal to or greater than the required rate of return. For mutually exclusive projects, the project that generates the higher ARR is accepted.

## Examples of calculating the return on investment (ARR)

The following examples illustrate the methods used to calculate the ARI.

Example 1: Project A has an initial investment of \$ 150,000 and expects an annual inflow of \$ 40,000 over 5 years. The straight-line method is used for depreciation. The scrap value at the end of the 5th year is approximately \$ 20,000. ARR can be calculated as,

Example 2: Compare the following mutually exclusive projects based on the FER and identify which project is financially feasible.

Project a

Since the ARR of project A is higher than that of B, it is cheaper than that of project B.